Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o No ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o No ý

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes ý No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes ý No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. ý

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
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smaller reporting company)

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Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
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The aggregate market value of the shares of Common Stock of the registrant held by non-affiliates on September 30, 2012 was approximately
$304.4 million.

As
of June 6, 2013, there were 304,762,788 shares of the registrant's Common Stock issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement relating to the registrant's 2013 annual meeting of stockholders are incorporated by reference into Part III of
this report to the extent described therein.

Capstone Turbine Corporation ("Capstone" or the "Company") develops, manufactures, markets and services microturbine technology
solutions for use in stationary distributed power generation applications, including cogeneration (combined heat and power ("CHP"), integrated combined heat and power ("ICHP"), and combined cooling,
heat and power ("CCHP")), renewable energy, natural resources and critical power supply. In addition, our microturbines can be used as battery charging generators for hybrid electric vehicle
applications. Microturbines allow customers to produce power on-site in parallel with the electric grid or stand alone when no utility grid is available. Several technologies are used to
provide "on-site power generation" (also called "distributed generation") such as reciprocating engines, solar power, wind powered systems and fuel cells. For customers who do not have
access to the electric utility grid, microturbines provide clean, on-site power with lower scheduled maintenance intervals and greater fuel flexibility than competing technologies. For
customers with access to the electric grid, microturbines provide an additional source of continuous duty power, thereby providing additional reliability and potential cost savings. With our
stand-alone feature, customers can produce their own energy in the event of a power outage and can use microturbines as their primary source of power for extended periods. Because our microturbines
also produce clean, usable heat energy, they provide economic advantages to customers who can benefit from the use of hot water, chilled water, air conditioning and heating. Our microturbines are sold
primarily through our distributors. Our distributors install the microturbines. Service is provided primarily by our global distribution network. Together we offer new and remanufactured parts as well
as a comprehensive Factory Protection Plan ("FPP"). Successful implementation of microturbines relies on the quality of the microturbine, marketability for appropriate applications, and the quality of
the installation and support.

We
believe we were the first company to offer a commercially available power source using microturbine technology. Capstone offers microturbines designed for commercial, industrial, and
utility users with product offerings ranging from 30 kilowatts ("kW") to one megawatt in electric power output. Our 30 kW ("C30") microturbine can produce enough electricity to power a small
convenience store. The 65 kW ("C65") microturbine can produce enough heat to provide hot water to a 100-room hotel while also providing about one-third of its electrical
requirements. Our 200 kW ("C200") microturbine is well suited for larger hotels, office buildings and wastewater treatment plants, among others. By packaging the C200 microturbine power modules into
an International Organization for Standardization ("ISO") sized container, Capstone has created a family of microturbine offerings from 600 kW up to one megawatt in a compact footprint. Our 1000 kW
("C1000 Series") microturbines are well suited for utility substations, larger commercial and industrial facilities and remote oil and gas applications. Our microturbines combine patented
air-bearing technology, advanced combustion technology and sophisticated power electronics to form efficient and ultra-low emission electricity and cooling and heat production
systems. Because of our air-bearing technology, our microturbines do not require liquid lubricants. This means they do not require routine maintenance to change and dispose of oil or other
liquid lubricants, as do the most common competing products. Capstone microturbines can be fueled by various sources, including natural gas, propane, sour gas, renewable fuels such as landfill or
digester gas, kerosene, diesel and biodiesel. The C65 and C200 microturbines are available with integrated heat exchangers, making them easy to engineer and install in applications where hot water is
used. Our products produce exceptionally clean power. Our C65 was certified by the California Air Resources Board ("CARB") as meeting its stringent 2007 emissions requirementsthe same
emissions standard used to certify fuel cells and the same emissions levels as a
state-of-the-art central power plant. Our C65 Landfill and Digester Gas systems were certified in January 2008 by CARB as meeting 2008 waste gas emissions
requirements for landfill and digester gas applications. Our C200 Landfill and

Digester
Gas systems were certified in November 2010 by CARB as meeting 2008 waste gas emissions requirements for landfill and digester gas applications.

On
February 1, 2010, we acquired the 100 kW ("TA100") microturbine product line from Calnetix Power Solutions, Inc. ("CPS") and entered into a manufacturing
sub-contract agreement and an original equipment manufacturer agreement with selected exclusive rights to package a combined microturbine and waste heat recovery generator product. The
TA100 microturbine is most similar to the Capstone product design compared to other microturbine products in the industry and the 100 kW rating fits well between our C65 and C200 microturbines. The
125 kW waste heat recovery generator can be directly fired by the exhaust of six C65 or two C200 microturbines to provide a total of over 500 kW of clean and efficient green power in
applications where the microturbine exhaust is not otherwise utilized, such as CHP or CCHP.

We
sell complete microturbine units, subassemblies, components and various accessories. We also remanufacture microturbine engines and provide after-market parts and services. Our
microturbines are sold primarily through distributors and Original Equipment Manufacturers ("OEMs"). Distributors purchase our products for sale to end users and also provide application engineering
and installation support. Distributors are also required to provide a variety of additional services, including engineering the applications in which the microturbines will be used, installation
support of the products at the end users' sites, commissioning the installed applications and providing post-commissioning service. Our distributors perform as value-added resellers.
OEMs integrate Capstone's products into their own product solutions.

To
assure proper installation of Capstone microturbine systems, we have instituted a Factory Trained Installer ("FTI") training and certification program. Personnel from our distributors
and OEMs, as well as design engineering firms, contractors and end users attend this FTI training. We offer to assist all customers by reviewing their installation designs to confirm that the
technical requirements for proper operation have been met, such as electrical interconnections, load requirements, fuel type and pressure, cooling air flow and turbine exhaust routing. As part of the
microturbine commissioning process, we also receive a checklist to confirm that the final installation adheres to Capstone technical requirements before we accept any warranty obligations. This is
aimed at providing the end user with a proper installation that will operate as expected for the life of the equipment.

Capstone
has a factory direct service offering for commissioning and post-commissioning service. Through our global distribution network, we offer a comprehensive FPP for a
fixed annual fee to perform regularly scheduled and unscheduled maintenance as needed. In January 2011, we expanded the FPP to include total microturbine plant operations if required by the end use
customer. Capstone provides factory and on-site training to certify all personnel that are allowed to perform service on our microturbines. Individuals who are certified are called
Authorized Service Providers ("ASPs") and must be employed by a distributor in order to perform work pursuant to a Capstone FPP. The majority of our distributors provide these services.

This
Annual Report on Form 10-K (this "Form 10-K") refers to Capstone's fiscal years ending March 31 as its "Fiscal" years.

Our Products

We began commercial sales of our C30 products in 1998, targeting the emerging distributed generation industry that was being driven by
fundamental changes in power requirements. In September 2000, we shipped the first commercial unit of our 60 kW microturbine ("C60"), which was replaced by the C65 model during the quarter ended
March 31, 2006. We began shipping the C60 Integrated CHP solution in 2003. The first commercial C200 microturbine was shipped on August 28, 2008. Our C1000 Series product was developed
based on Capstone's C200 microturbine engine. The C1000 Series product can be configured into 1,000 kW, 800 kW and 600 kW solutions in a single

ISO-sized
container. The first commercial shipment of our C1000 Series product was on December 29, 2008. We began shipping TA100 microturbines in March 2010.

During
Fiscal 2013, we booked total orders of $112.6 million for 765 units, or 107.2 megawatts, compared to $122.5 million for 637 units, or 136.3 megawatts, during Fiscal
2012. We shipped 628 units with an aggregate of 103.2 megawatts, generating revenue of $102.7 million compared to 627 units with an aggregate of 96.1 megawatts, generating revenue of
$89.9 million during Fiscal 2012. Total backlog as of March 31, 2013 increased $9.9 million, or 7%, to $148.9 million from $139.0 million at March 31, 2012.
As of March 31, 2013, we had 816 units, or 162.8 megawatts, in total backlog compared to 679 units, or 158.8 megawatts, at the same date last year. The timing of the backlog is based on
the requirement date indicated by our customers. However, based on historical experience management expects that a significant portion of our backlog may not be shipped within the next twelve months.
The timing of shipments is subject to change based on several variables (including customer deposits, payments,
availability of credit and customer delivery schedule changes), most of which are not in our control and can affect the timing of our revenue.

The
following table summarizes our backlog:

As of March 31,

2013

2012

Megawatts

Units

Megawatts

Units

C30

5.8

193

3.4

112

C65

28.4

438

23.1

356

TA100

2.3

23

2.8

28

C200

4.6

23

9.0

45

C600

10.2

17

10.8

18

C800

7.2

9

6.4

8

C1000

103.0

103

102.0

102

Waste heat recovery generator

1.3

10

1.3

10

Total Backlog

162.8

816

158.8

679

Capstone
microturbines are compact, lightweight and environmentally friendly generators of electricity and heat compared to competing technologies. They operate on the same principle as
a jet engine with the added capability of using a variety of commercially available fuels. For example, our microturbines can operate on low British Thermal Unit ("BTU") gas, which is gas with lower
energy content, and can also operate on gas with a high amount of sulfur, known in the industry as sour gas. Examples of these fuel sources include methane from facilities such as wastewater treatment
plants, landfills and anaerobic digesters.

Our
microturbines incorporate four major design features:



advanced combustion technology;



patented air-bearing technology;



digital power electronics; and



remote monitoring capability.

Our
advanced combustion technology allows Capstone microturbines to achieve low emissions with a design geared towards manufacturability. These low emission levels not only provide an
environmentally friendly product, but also eliminate permitting requirements in several municipalities for continuously operated onsite power generation. The air-bearing system allows the
microturbine's single moving assembly to produce power without the need for typical petroleum-based lubrication.

Air-bearings
use a high-pressure field of air rather than petroleum lubricants. This improves reliability and reduces maintenance such as oil changes. The electronic controls
manage critical functions and monitor operations of the microturbine. For instance, our electronics control the microturbine's speed, temperature and fuel flow and communicate with external networks
and building management systems. The power electronics coordinate with the grid when the units are operated in a grid-connect mode and with the onboard battery when equipped for
stand-alone mode. All control functions are performed digitally. Performance is optimized, resulting in lower emissions, higher reliability and high efficiency over a variable power range.

The
electrical output of our units can be paralleled in multiple unit configurations through our Advanced Power Server product and a digital communications cable to serve larger
installations requiring electrical loads up to ten megawatts.

Our
products can operate:



connected to the electric utility grid as a current source;



on a stand-alone basis as a voltage source;



multipacked to support larger loads as a "virtual single" unit; and



in dual mode, where the microturbine operates connected to the electric utility grid or operates independently.

We
also offer C65 and C200 ICHP systems. These systems combine the standard C65 and C200 microturbine unit with a Heat Recovery Module that provides electricity and heats water.

Our
family of products is offered in the following configurations:

C30

C65

TA100

C200

C1000 Series

Fuel Types

Grid
Connect

Dual
Mode

Grid
Connect

Dual
Mode

Grid
Connect

Dual
Mode

Grid
Connect

Dual
Mode

Grid
Connect

Dual
Mode

Low pressure natural gas

X

X

X

X

X

X

X

X

X

X

High pressure natural gas

X

X

X

X

X

X

X

X

X

X

Compressed natural gas

X

X

X

X

X

X

X

X

X

X

Landfill gas

X

X

X

X

Digester gas

X

X

X

X

Gaseous propane

X

X

X

X

X

X

X

X

High pressure sour gas

X

X

X

X

X

X

X

X

Diesel

X

X

X

X

X

X

Kerosene

X

X

X

X

We
offer various accessories for our products including rotary gas compressors with digital controls, heat recovery modules for CHP applications, dual mode controllers that allow
automatic transition between grid connect and stand-alone modes, batteries with digital controls for stand-alone or dual-mode operations, power servers for large multipacked installations,
protocol converters for Internet access, packaging options and miscellaneous parts such as frames, exhaust ducting and installation hardware. We also sell microturbine components and subassemblies.

convert the variable frequency, up to a maximum of 1,600 Hertz and variable voltage power produced by the generator into a
usable output of either 50 or 60 Hertz AC for stationary applications or DC for hybrid electric vehicle applications; and



provide digital communications to externally maintain and control the equipment.

In
addition, our proprietary Capstone Remote Monitoring Software ("CRMS") allows end users to remotely operate and manage the microturbine. Unlike the technology of other power sources
that require manual monitoring and maintenance, the CRMS allows end users to remotely and efficiently monitor performance, power generation and time of operation using our CRMS interface software with
standard personal computers. This remote capability can provide end users with power generation flexibility and cost savings. Capstone is currently developing an Internet based system to provide
real-time continuous remote monitoring and diagnostics to customers who purchase the service.

The
C30 microturbines were initially designed to operate connected to an electric utility grid and to use a high pressure natural gas fuel source. We have expanded our microturbine's
functionality to operate with different fuels. The combustor system remains the same for all fuels except for the fuel injectors, which currently vary between liquid and gaseous fuels. The Capstone
microturbine's multi-fuel capability provides significant competitive advantages with respect to some of our selected vertical markets.

In
2002, the California Energy Commission certified our C30 and C60 microturbines as the first products to comply with the requirements of its "Rule 21" grid interconnection
standard. This standard streamlines the process for connecting distributed generation systems to the grid in California. The benefits of achieving this standard include avoiding both costly external
equipment procurement requirements and extensive site-by-site and utility-by-utility analysis. Our protective relay functionality has also been
recognized by the State of New York, which has pre-cleared our microturbines for connection to New York's electric utility grid.

Our
C60 microturbine was the first combustion power generation product to be certified by the CARB as meeting its stringent distributed generation emissions standards that went into
effect in 2003. Our C65 microturbine now meets the even more stringent CARB 2007 standard for natural gas.

The
TA100 microturbine offers a digital communication interface which can be connected to an external controller (not sold by Capstone) to provide multiple unit and dual mode dispatching
functionality. An external synchronization board is provided to parallel the electrical output in multiple unit configurations for stand-alone operation.

We
are the first microturbine manufacturer to achieve UL Class I, Division 2 certification for operation in hazardous-area oil and gas applications. These specially
packaged systems are applied in oil and gas production areas with potentially explosive environments.

In
September 2009, we received UL certification for our C200 grid-connect and stand-alone microturbine as meeting the UL 2200 stationary engine generator standards and the UL
1741 utility interconnection requirements.

In
June 2010, we received UL certification for our C1000 Series grid-connect and stand-alone microturbine as meeting the UL 2200 stationary engine generator standards and the
UL 1741 utility interconnection requirements.

Worldwide, stationary power generation applications vary from huge central stationary generating facilities up to 1,000 MW to
back-up generators as small as two kW. Historically, power generation in most developed countries such as the United States has been part of a regulated utility system. A number of
developments related primarily to the deregulation of the utility industry as well as significant technology advances have broadened the range of power supply choices available to all types of
customers.

Capstone
products serve multiple vertical markets worldwide. Within the markets served, we focus on vertical markets that we have identified as having the greatest near-term
potential. In the markets we are focusing on, which are energy efficiency, renewable energy, natural resources, critical power supply and mobile products, we have identified specific targeted vertical
market segments.

Energy EfficiencyCHP/CCHP

Energy efficiency maximizes the use of energy produced by the microturbines, reduces emissions compared with traditional power
generation and enhances the economic advantage to customers. Energy efficiency uses both the heat and electric energy produced in the power generation process. Using the heat and electricity created
from a single combustion process increases the efficiency of the system from approximately 30% to 75% or more. The increased operating efficiency reduces overall greenhouse gas emissions compared with
traditional independent sources such as power generation and local thermal generation and, through displacement of other separate systems, can reduce operating costs. Our microturbines' emissions of
commonly found air pollutants ("criteria pollutants") such as nitrogen oxides ("NOx"), carbon monoxide ("CO") and volatile organic compounds ("VOCs") are lower than those from the on-site
boilers that our CHP system displaces, meaning that local emissions of these pollutants are actually reduced when a Capstone energy efficiency CHP system is installed. This high CHP efficiency also
means more efficient use of fuel and can reduce net utility costs for end users. The most common uses of heat energy include space heating and air conditioning, heating and cooling water, as well as
drying and other applications. For example, we have used the heat generated by the microturbines to supply hot water solutions for hotels, office buildings and retail, commercial and industrial
customers. When our microturbine exhaust drives an absorption chiller, the chiller produces chilled water for air conditioning and other uses.

There
are energy efficiency markets for CHP and CCHP applications worldwide. A study conducted for the US Department of Energy ("DOE") calculated the total potential energy efficiency
CHP market in the United States to be over 35.5 gigawatts through 2020. Many governments have encouraged more efficient use of the power generation process to reduce pollution, lower dependence on
fossil fuels and control the cost of locally produced goods. To access these markets, we have entered into agreements with distributors which have engineered energy efficiency CHP packages that
utilize the hot exhaust air of the microturbine for heating water and also use the hot exhaust to run an absorption chiller for air conditioning. We also offer our own integrated energy efficiency CHP
and CCHP product for the C65, C200 and C1000 Series products.

Renewable Energy

Our microturbines can use renewable methane gases from landfills, wastewater treatment facilities and other biogas applications such as
food processing and agricultural waste, referred to as green waste, and cow, pig and chicken manure. They can burn these renewable waste gases with minimal emissions, thereby, in some cases, avoiding
the imposition of penalties incurred for pollution while simultaneously producing electricity from this "free" renewable fuel for use at the site or in the surrounding areas. The microturbines have
demonstrated effectiveness in these applications and

outperform
conventional combustion engines in a number of situations, including when the gas contains a high amount of sulfur.

Capstone
released for sale the C65 stand-alone digester product for sale in the renewable energy market segment in 2007. This product is targeted at remote villages in third-world
countries with wastewater treatment facilities that offer a valuable source of fuel which can be converted to electricity. A joint applications and engineering team evaluated the performance of the
existing C65 digester gas system to ensure that the combustion system would be stable from 0 to 100% power output. Minor controls changes were implemented to increase stability at low power levels.
The ability to convert this low BTU fuel to electricity along with the high reliability and low maintenance features of this product make it well suited for this market.

In
February 2010, we entered into an agreement with CPS to purchase 125 kW waste heat recovery generators in exchange for certain minimum purchase requirements through December 2015.
Pursuant to this agreement, we have exclusive rights to sell the zero-emission waste heat recovery generator for all microturbine applications and for applications 500 kW or lower where
the source of heat is the exhaust of a reciprocating engine used in a landfill application.

Natural ResourcesOil, Natural Gas, Shale Gas & Mining

On a worldwide basis, there are thousands of locations where the drilling, production, compression and transportation of natural
resources and other extraction and production
processes create fuel byproducts, which traditionally have been released or burned into the atmosphere. Our microturbines are installed in the natural resource market to be used in oil and gas
exploration, production, compression and transmission sites both onshore and offshore as a highly reliable critical source of power generation. In addition, our microturbines can use flare gas as a
fuel to provide prime power. Typically these oil and gas or mining operations have no electric utility grid and rely solely on Capstone's microturbine for reliable low emission power supply.

Many
major oil and gas companies are exploring large shale reserves, or plays, in the United States. In mid-2010 Capstone sold its first microturbines into the U.S. shale gas
market in the Eagle Ford and Marcellus shale plays. The market for Capstone microturbines in this industry is vast. The shale gas market is expected to grow substantially, especially since the U.S.
Environmental Protection Agency's ("EPA") Clean Air Act has strict requirements for emissions levels at natural gas sites.

The
C200 product is offered for sale configured to meet Class 1 Zone 2 hazardous location requirements for the oil and gas market. Hazardous location requirements are met through
package ventilation changes for purging and pressurizing package air to avoid potential flammable mixtures as well as controls for emergency disconnect of fuel and electrical sources. The package is
upgraded to stainless steel construction to withstand the corrosive offshore environments where these units are installed. Oil and gas customers prefer the low maintenance and high reliability
attributes offered by our turbines to ensure continued production. Capstone also offers C30 and C65 microturbine products in similar configurations.

Critical Power Supply

Because of the potentially catastrophic consequences of even momentary system failure, certain power users such as high technology and
information systems companies require particularly high levels of reliability in their power service. Capstone's critical power supply offerings are the world's only microturbine powered
Uninterruptible Power Source ("UPS") solutions that can offer clean, IT-grade power produced from microturbines, the utility or a combination of both. We offer two microturbine-powered UPS
solutions that support prime and dispatched power options. The Capstone UPSource microturbine-powered UPS solution provides prime or emergency power solutions. Capstone's Hybrid UPS microturbine
powered solution provides power when dispatched in high efficiency, standard UPS

and
emergency power solutions. Both critical power supply products offer 99.999999% reliability when the product has at least one independent backup. Dual mode units operating in a prime power
configuration can support a 150% overload for 10 seconds during transient conditions. Dual mode units operating in grid parallel mode can provide customers a back-up power system with an
economic return. These systems offer high onsite energy efficiency when combined with a heat exchanger (CHP) to create hot water or with a chiller (CCHP) for air conditioning at these facilities. This
configuration, when combined with the Capstone Dual Mode Controller, can transition from the grid parallel mode to prime power mode in less than 10 seconds.

Mobile ProductsHybrid Electric Vehicles

Our technology is also used in hybrid electric vehicle ("HEV") applications. Our customers have applied our products in hybrid electric
vehicles such as transit buses and trucks. In these applications the microturbine acts as an onboard battery charger to recharge the battery system as needed. The benefits of microturbine hybrids
include extended range, fuel economy gains, quieter operation, reduced emissions and higher reliability compared with traditional internal combustion engines. Internal combustion diesel engine
manufacturers have been challenged for the last several years to develop technology improvements, prior to aftertreatment that reduce emissions to levels specified by the EPA and CARB 2007 and 2010
standards. Many manufacturers are incorporating aftertreatment that increases upfront equipment costs, vehicle weight and life cycle costs and may reduce overall engine efficiency.

Mobile ProductsMarine

Our technology is also used in marine applications. Our customers have applied our products in the commercial vessel and luxury yacht
markets. The most immediate market for our marine products is for use as ship axillaries. In this application, the microturbines provide power to the vessel's electrical loads and, in some cases, the
vessel is able to utilize the exhaust energy to increase the overall efficiency of the application, reducing overall fuel consumption and emissions. The other application is similar to our HEV
application where the vessel is driven by an electric propulsion system and the microturbine serves as an on board range extender. Our marine customers use both our liquid fueled and natural gas
products. Liquefied natural gas (LNG) is in its early stages as a marine fuel, and the number of vessels powered by LNG is forecasted to double every two years over the next decade. Vessel owners can
receive the same benefits as users of stationary Capstone products: low emissions with no aftertreatment, long maintenance intervals, high reliability, low noise and no vibration.

Sales, Marketing and Distribution

We primarily sell our microturbine product, parts and service through distributors. Our typical terms of sale include shipment of the
products with title, care, custody and control transferring at our dock, payment due anywhere from in advance of shipment to 90 days from shipment, and warranty periods of approximately 15 to
18 months from shipment. We typically do not have customer acceptance provisions in our agreements.

North America

We have distribution agreements with a number of companies throughout North America for the resale of our products. Many of these
distributors serve multiple markets in their select geographic regions. The primary markets served in this region have been energy efficiency, renewable energy, natural resources and mobile products.
The energy efficiency and natural resources vertical markets are expected to grow as a result of an increased supply of low price natural gas.

In
developing our sales opportunities we have identified the need to address various requirements present in our target localities. These requirements include electric grid
interconnection standards, gas utility connection requirements, building and fire safety codes and various inspections and approvals. The costs and scheduling ramifications of these various approvals
can be significant to the completion of an installation. Our goal is to work with the applicable regulating entities to establish compliant standards for the installation of our microturbines so that
the costs and installation timelines are minimized for our customers. Management believes that we can create market advantages for our products through enhancing the ease of deploying our distributed
generation solutions.

Asia and Australia

Our sales and marketing strategy in Asia and Australia has been to develop and strengthen distributor relationships throughout these
continents.

Our
market focus in Asia and Australia is energy efficiency, renewable energy and natural resources. Our historical sales in Southeast Asia and Australia have primarily been in the CHP,
CCHP and the oil and gas market. Other areas in Asia and the Pacific Rim offer attractive opportunities as well. South Korea and China are areas where renewable energy applications and CHP and CCHP
solutions are expected to experience market growth.

Europe and Russia

To address the European market, including Russia, we are strengthening our relationships with existing and new distributors and have
increased Capstone local sales and service support. We have an office in Europe for the purpose of working with our distributors there on a daily basis to realize growth opportunities. We have
established a spare parts distribution center in Europe to make parts readily available to our distributors. Europe has a history of extensive use of distributed generation technologies. We expect
revenue from the European market will continue to be soft as a result of general economic conditions. Continued financial instability there could have an adverse effect on our business.

South America

Our sales and marketing strategy in South America has been to develop and strengthen distributor relationships throughout South
America.

Our
market focus in South America is energy efficiency, renewable energy and natural resources. Our historical sales in South America have primarily been in the natural resources market.

Revenue

For geographic and segment revenue information, please see Note 2Summary of Significant Accounting
PoliciesSegment Reporting in the "Notes to Consolidated Financial Statements."

Customers

Sales to Horizon Power Systems ("Horizon"), one of the Company's domestic distributors, accounted for 27%, 19% and 18% of our revenue
for the years ended March 31, 2013, 2012 and 2011, respectively. Sales to BPC Engineering ("BPC"), one of the Company's Russian distributors, accounted for 11%, 26% and 23% of our revenue for
the years ended March 31, 2013, 2012 and 2011, respectively. Additionally, BPC and Regatta Solutions, Inc., one of the Company's domestic distributors, accounted for 35% and 11%,
respectively, of net accounts receivable as of March 31, 2013. BPC accounted for 44% of net accounts receivable as of March 31, 2012.

The market for our products is highly competitive. Our microturbines compete with existing technologies such as reciprocating engines
and may also compete with emerging distributed generation technologies, including solar power, wind-powered systems, fuel cells and other microturbines. Many potential customers rely on
the utility grid for their electrical power. As many of our distributed generation competitors are large, well-established companies, they derive advantages from production economies of
scale, worldwide presence, brand recognition and greater resources, which they can devote to product development or promotion.

Generally,
power purchased from the electric utility grid is less costly than power produced by distributed generation technologies. Utilities may also charge fees to interconnect to
their power grids. However, we can provide economic benefits to end users in instances where the waste heat from our
microturbine has value (CHP and CCHP), where fuel costs are low (renewable energy/renewable fuels), where the costs of connecting to the grid may be high or impractical (such as remote power
applications), where reliability and power quality are of critical importance, or in situations where peak shaving could be economically advantageous because of highly variable electricity prices.
Because Capstone microturbines can provide a reliable source of power and can operate on multiple fuel sources, management believes they offer a level of flexibility not currently offered by other
technologies such as reciprocating engines.

Our
reciprocating engine competitors have products and markets that are well developed and technologies that have been proven for some time. A reciprocating engine, also known as an
internal combustion engine, is similar to those used in automotive applications. Reciprocating engines are popular for primary and back-up power applications despite higher levels of
emissions, noise and maintenance. These technologies, which typically have a lower up-front cost than microturbines, are currently produced by Caterpillar Inc., Cummins Inc.,
Deutz Corporation, GE Gas Engines which now includes Waukesha, MAN SE, Tecogen, Inc. and Wärtsilä Corporation, among others.

Our
microturbines may also compete with other distributed generation technologies, including solar power, wind power systems and fuel cells. Solar and wind powered systems produce no
emissions. The main drawbacks to solar and wind powered systems are their dependence on weather conditions, the utility grid and high capital costs that can often make these systems uneconomical
without government subsidies depending upon geographic locale and application of the technology. Although the market for fuel cells is still developing, a number of companies are focused on markets
similar to ours, including FuelCell Energy Inc., ClearEdge Power, Bloom Energy Corporation, LG Fuel Cell Systems, a business unit of LG Electronics, Plug Power Inc. and Ballard Power
Systems Inc. Fuel cells have lower levels of NOx, CO, VOCs and other criteria pollutant emissions than our microturbines. Fuel cells, like solar and wind powered systems, have received higher
levels of incentives for the same type of applications as microturbines. Management believes that, absent these higher government incentives, microturbines provide a better value to end users in most
applications. However, over the medium-to-long term, fuel cell technologies that compete more directly with our products may be introduced.

We
also compete with other companies who have microturbine products, including FlexEnergy and Turbec S.p.A.

Overall,
we compete with end users' other options for electrical power and heat generation on the basis of our microturbine's ability
to:



provide power when a utility grid is not available or goes out of service;



reduce total cost of purchasing electricity and fuel;



improve electric power availability and provide high power quality;



operate on multiple fuel types;



reduce emissions (both criteria pollutants and greenhouse gases);



simplify operation; and



control maintenance costs and associated disposal of hazardous materials.

Our markets can be positively or negatively impacted by the effects of governmental and regulatory matters. We are affected not only by
energy policy, laws, regulations and incentives of governments in the markets in which we sell, but also by rules, regulations and costs imposed by utilities. Utility companies or governmental
entities may place barriers on the installation or interconnection of our product with the electric grid. Further, utility companies may charge additional fees to customers who install
on-site power generation, thereby reducing the electricity they take from the utility, or for having the capacity to use power from the grid for back-up or standby purposes.
These types of restrictions, fees or charges could hamper the ability to install or effectively use our product or increase the cost to our potential customers for using our systems. This could make
our systems less desirable, thereby adversely affecting our revenue and profitability. In addition, utility rate reductions can make our products less competitive which would have a material adverse
effect on our operations. These costs, incentives and rules are not always the same as those faced by technologies with which we compete. However, rules, regulations, laws and incentives could also
provide an advantage to our distributed generation solutions as compared with competing technologies if we are able to achieve required compliance in a lower cost, more efficient manner. Additionally,
reduced emissions and higher fuel efficiency could help our customers combat the effects of global warming. Accordingly, we may benefit from increased government regulations that impose tighter
emission and fuel efficiency standards.

Capstone
continues to engage with Federal and State policymakers to develop government programs to promote the deployment of Capstone's low emission and energy efficient products. In
2012, President Obama called for 40 GW of additional CHP power generation to be installed in the United States by 2020. Legislation is under consideration by Congress that could stimulate the market
for Capstone products by providing incentives to encourage energy efficiency. We cannot provide assurance that any such legislation will be enacted, however, or that it will benefit us if enacted.
Several state programs were introduced in 2011 and 2012 that provide financial support to combined heat and power projects, and some of these programs have begun to benefit Capstone's customers. For
example, in New York, Capstone systems are pre-qualified for financial incentives available through the NYSERDA CHP Acceleration Program. In Ohio, legislation passed allowing for CHP to
qualify as an energy efficiency measure under the state's Energy Efficiency Resource Standard.

The
United States Government is focused on promoting exports of American products with a specific emphasis on clean energy goods. Capstone participates in export promotion activities
such as trade missions which help us enter new markets by facilitating interactions with foreign buyers and distributors. Capstone's customers have utilized trade financing through the Export-Import
Bank of the United States ("Ex-Im Bank") in the past, and Capstone has seen more customers use Ex-Im Bank financing for projects in 2011 and 2012.

Government
funding can impact the rate of development of new technologies. While we continue to receive development funding, committed amounts remaining are relatively low. Competing new
technologies generally receive larger incentives and development funding than do microturbines.

Sourcing and Manufacturing

We are focused on continuously improving our supply chain effectiveness, strengthening our manufacturing processes and increasing
operational efficiencies within our organization. Our microturbines are designed to achieve high volume, low cost production objectives. Our manufacturing designs include the use of conventional
technology, which has been proven in high volume automotive and turbocharger production for many years. Many components used in the manufacture of our products are readily fabricated from commonly
available raw materials or off-the-shelf items available from multiple supply sources; however, certain items are custom made to meet our specifications. We believe that in
most cases, redundant capacity exists at our suppliers and that alternative sources of

supply
are available or could be developed within a reasonable period of time. We also have an on-going program to identify single-source components and to develop alternative
back-up supplies and we regularly reassess the adequacy and abilities of our suppliers to meet our needs. We continue to evaluate and implement new systems designed to provide improved
quality, reliability, service, greater efficiency and lower supply chain costs. We have substantially increased our focus on process controls and validations, supplier controls, distribution controls
and providing our operations teams with the training and tools necessary to drive continuous improvement in product quality. In addition, we remain focused on examining our operations and general
business activities to identify cost-improvement opportunities in order to enhance our operational effectiveness. Our ability to leverage these capabilities may be affected by the current
variability in our demand volumes and forecasting. Our strategy is to identify primary and secondary sources for critical components when available to minimize factory down time due to unavailability
of such parts, which could affect our ability to meet manufacturing schedules.

We
assemble and test units as well as manufacture air-bearings and certain combustion system components at our facility in Chatsworth, California. Additionally, we assemble
and test our C200 and C1000 Series products and manufacture recuperator cores at our facility in Van Nuys, California. Management believes our manufacturing facilities located in Chatsworth and Van
Nuys, California have a combined production capacity of approximately 2,000 units per year, depending on product mix. Excluding working capital requirements, management believes we can expand our
combined production capacity to approximately 4,000 units per year, depending on product mix, with approximately $10 to $15 million of capital expenditures. We have not committed to this
expansion nor identified a source for its funding, if available.

Solar
Turbines Incorporated ("Solar"), a wholly owned subsidiary of Caterpillar Inc., was our sole supplier of recuperator cores prior to 2001. In 2000, we exercised an option to
license Solar's technology, which allows us to manufacture these cores ourselves and we began manufacturing them in June 2001. The cores are subject to a per-unit royalty fee. As of
March 31, 2013, cumulative royalties of $0.4 million have been paid under the terms of the licensing agreement with Solar.

In
September 2007, we entered into a Development and License Agreement (the "Development Agreement") with UTCP, a division of United Technologies Corporation. The Development Agreement
engaged UTCP to fund and support our continued development and commercialization of our 200 kilowatt ("C200") microturbine. In return we agreed to pay a predetermined fixed rate for each
microturbine system covered by the agreement. In August 2009, the Development Agreement was assigned by UTCP to Carrier Corporation ("Carrier"). As of March 31, 2013, cumulative royalties of
$9.8 million have been paid under the terms of the licensing agreement with Carrier.

On
April 28, 2011, we purchased from CPS for $2.3 million the remaining TA100 microturbine inventory that was not consumed as part of the TA100 manufacturing process and
acquired the manufacturing
equipment. On February 1, 2010, the Company and CPS entered into an agreement pursuant to which we agreed to purchase 125 kW waste heat recovery generator systems from CPS, which agreement was
subsequently assigned to General Electric Company ("GE") in October of 2010. In exchange for certain minimum purchase requirements through December 2015, we have exclusive rights to sell the
zero-emission waste heat recovery generator for all microturbine applications and for applications 500 kW or lower where the source of heat is the exhaust of a reciprocating engine used in
a landfill application. As of March 31, 2013, we were not in compliance with the minimum purchase requirements in the agreement. Loss of exclusivity is dependent upon receiving proper
notification from GE as set forth in the agreement.

For the fiscal years ended March 31, 2013, 2012 and 2011, R&D expenses were $9.0 million, $8.2 million and
$7.0 million and were 7%, 7% and 9% of total revenue, respectively. R&D expenses are reported net of benefits from cost-sharing programs, such as DOE grants and the Development
Agreement with Carrier. Benefits from cost-sharing programs were $1.7 million, $0.8 million and $0.9 million for Fiscal 2013, 2012 and 2011, respectively. Our R&D
activities enabled us to become one of the first companies to develop a commercially available microturbine that operates in parallel with the grid. We were the first company to successfully
demonstrate a commercially available microturbine that operates on a stand-alone basis.

We
are focused on making improvements to our C30, C65, and C200 products to be compliant with the new VDE-AR-N 4105 requirements in Europe for decentralized power
generation. These improvements require hardware and software changes to our power inverters to allow power that can be fed into the grid smoothly and efficiently. In addition, we continue to work cost
reduction activities to improve the direct material costs of our microturbine products. Current cost reduction activities are focused on leveraging the capabilities of our supply base through
identification of value added suppliers, working with existing suppliers to identify process and tooling improvements, entering into long term agreements and transitioning parts to low cost
manufacturing regions. Cross functional teams, including internal engineering resources and supplier resources, are used to drive changes with a focus on mutually beneficial long-term
relationships.

In
September 2011, we received CARB certification to the 2007 Fossil Fuel Standards for our C200 ICHP microturbine power systems. This standard represents the most stringent emissions
standard worldwide set to the Best Available Control Technology ("BACT") for large central power plants. To put these emissions levels in perspective, it is challenging to measure the extremely low
levels required with today's best emissions measurement equipment. These emissions levels were achieved through
scaling and optimization of Capstone existing lean premix combustion technology. Test emissions from both the C30 and C65 natural gas fueled microturbines measured dramatically less than the emissions
levels set forth by the CARB standard including NOx at 75% and CO at 96% less than the required levels. The emissions levels are set so low that the California Air Resources Board has not defined any
further limit reductions in the foreseeable future.

We
continue to release variants of the C200 product to provide the same features that we offer customers with our C30 and C65 microturbine products. A liquid fuel version of the C200
product has been developed with Capstone's lean premix combustion technology. This technology allows operation on various fuels by changing the injector to achieve the necessary fuel to air ratio
mixture, fuel atomization, stability, and exhaust emission levels. The control system is modified to incorporate required algorithm modifications for start/stop sequencing and load state operation.
Liquid fuel products are well suited for markets where customers do not have access to gaseous fuels but still demand the low emissions, low maintenance, and high reliability benefits offered by
Capstone's microturbine products. Capstone received the 2011 NOVA Award from the Construction Innovation Forum ("CIF") for its C65 Hybrid Uninterruptible Power Supply ("UPS") Microturbine at Syracuse
University's data centerlabeled one of the greenest data centers in the world. The product utilizes Capstone's inverter electronics and controls technology to provide continuous power
quality to the customer critical load. The load inverter is connected through a central power bus to provide power from one of three available power sources including the utility grid, battery storage
system, or microturbine generator. Power to the critical load is synchronized to an available utility grid to allow direct bypass of the critical load to the utility grid. This redundant functionality
is provided in a single integrated package that can be scaled to a larger seamless power unit through Capstone's multipack feature. These units can also be combined with a heat recovery module or an
absorption chiller to provide higher total output efficiency. Unlike current UPS products combined with reciprocating engines for backup, the low emissions of the Capstone Hybrid UPS product allow for
continuous

operation
year round allowing customers the ability to receive a payback on their capital equipment investment. In November 2012, we received UL certification for our C65 HUPS microturbine system as
meeting the UL 2200 stationary engine generator standards and the UL 1741 utility interconnection requirements.

We
are continuing to work on product improvements to our C30 and C65 microturbine products targeted at the hybrid electric bus and truck market. Because of Capstone's single moving
assembly, manufacturers believe there is also the opportunity to produce a lower cost product in larger automotive volumes. Our current focus is on a next generation product that would include
existing components and a liquid-cooled set of electronics that are consistent with the size, cost and cooling strategies employed on vehicles today. During the 2011 Hybrid Truck User's Forum in
Baltimore Maryland, it was announced that both Kenworth Truck Company and Peterbilt Motors Company are working with Capstone to demonstrate Class 7 and Class 8 microturbine range
extended series hybrid trucks. Both vehicles are concept trucks intended to quantify the performance, efficiency, and economic
benefits of a microturbine-based series hybrid solution. Future development efforts will be based on the lessons learned from these programs. In the meantime, Capstone has other hybrid vehicle
customers that will benefit from continued development of this technology.

The
C65 Liquid Fuel microturbine demonstrated emissions levels which meet the CARB 2010 standards for Heavy Duty Diesel Engines ("HDDE"). These requirements are met using test procedures
which evaluate emissions performance through start/stop and load transient cycles. Capstone is able to meet these extremely low emissions requirements using its lean premix combustion technology with
no aftertreatment. Competitive reciprocating engine technologies require aftertreatment components that increase system cost, require frequent maintenance, and impact engine efficiency. The C30 Liquid
Fuel microturbine met these requirements in March 2009. In August 2011, we announced configurations of the C30 and C65 compressed natural gas ("CNG") fueled microturbines that meet extremely low
emission standards, including the U.S. Environmental Protection Agency and CARB 2010 emissions requirements for On-Road Heavy Duty Diesel Engines for Urban Bus. Test emissions from both
the C30 and C65 Natural Gas microturbines measured dramatically less than the emissions levels set forth by the CARB standard including NOx at 75% and CO at 96% less than the required levels. We
believe that future products will require the implementation of On Board Diagnostic (OBD) controls to gain certification through the CARB.

Capstone
is working with the Department of Energy ("DOE") on two next generation technology roadmap programs, including the Flexible Fuel Turbine System ("FFTS") and High Efficiency
Microturbine with integral heat recovery. The FFTS program is aimed at developing a microturbine system for operation on a range of higher BTU gaseous fuels, including synthetic gas ("SynGas")
produced by a biomass gasifier and hydrogen. The High Efficiency Microturbine with integral heat recovery is focused on improving microturbine electrical efficiency and overall system efficiency
utilizing heat recovery. We are currently focusing efforts on the development of the High Efficiency Microturbine with integral heat recovery system. In March 2013, Capstone successfully completed
proof-of-concept testing of the first C250 that produced 270 kW as part of the first phase of development to increase power and electrical efficiency. This milestone validates
significant design and aero-performance work and marks the most powerful engine ever produced by Capstone in the lab. Capstone is also working to boost the power capability of the power
electronics and electrical system required to support this higher power generator. The second phase of the program is expected to incorporate further engine efficiency improvements, resulting in a
product with a projected electrical efficiency of 42% and targeted power output of 370 kW. Improvements in efficiency are key to all markets as improved fuel efficiency benefits users through lower
operating costs. We expect to commercialize these products into the C200/C1000 product family upon successful project completion and acceptable technical readiness level.

We rely on a combination of patent, trade secret, copyright and trademark law and nondisclosure agreements to establish and protect our
intellectual property rights in our products. In this regard, we have obtained 106 U.S. and 36 international patents (in certain cases covering the same technology in multiple jurisdictions). The
patents we have obtained will expire between 2014 and 2027.

Management
believes that a policy of protecting intellectual property is an important component of our strategy of being the leader in microturbine system technology and will provide us
with a long-term competitive advantage. In addition, we implement security procedures at our plants and facilities and have confidentiality agreements with our suppliers, distributors,
employees and certain visitors to our facilities.

Organization and Employees

We were organized in 1988. On June 22, 2000, we reincorporated as a Delaware corporation.

As
of March 31, 2013, we had 217 employees. No employees are covered by collective bargaining arrangements. We consider relations with our employees to be good.

Available Information

This annual report on Form 10-K ("Annual Report"), as well as our quarterly reports on Form 10-Q,
current reports on Form 8-K and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") are made available free of charge on the Company's Internet website (http://www.capstoneturbine.com) as soon as reasonably practicable after such materials are electronically filed
with or furnished to the Securities and Exchange Commission ("SEC").

Item 1A. Risk Factors.

This document contains certain forward-looking statements (as such term is defined in Section 27A of the
Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Exchange Act pertaining to, among other
things,



our results of
operations;



profits and losses;



R&D activities;



sales expectations;



our ability to develop markets for our products;



sources for parts;



federal, state and local government regulations;



general business;



industry and economic conditions applicable to us;



the efficiency, reliability and environmental advantages of our products and their need for
maintenance;

These statements are based largely on our current expectations, estimates and forecasts and are subject to a number of risks and uncertainties. Actual results
could differ materially from those anticipated by these forward-looking statements. Factors that can cause actual results to differ materially include, but are not limited to, those discussed below.
Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The following factors should be considered in addition to the other
information contained herein in evaluating Capstone and its business. We assume no

obligation to update any of the forward-looking statements after the filing of this Annual Report to conform such statements to actual results or to changes in our expectations, except as may be
required by law.

The following are risk factors that could affect our business, financial condition, results of operations, and cash flows. These risk factors should be considered
in connection with evaluating the forward-looking statements contained in this Annual Report because these factors could cause actual results and conditions to differ materially from those projected
in forward looking statements. Before you invest in our publicly traded securities, you should know that making such an investment involves some risks, including the risks described below. Additional
risks of which we may not be aware or that we currently believe are immaterial may also impair our business operations or our stock price. If any of the risks actually occur, our business,
financial condition, results of operations or cash flow could be negatively affected. In that case, the trading price of our common stock could decline, and you may lose all or part of your
investment. In assessing these risks, investors should also refer to the other information contained or incorporated by reference in this Annual Report, our quarterly reports on
Form 10-Q and other documents filed by us from time to time.

Our operating history is characterized by net losses. We anticipate further losses and we may never become profitable.

Since inception, we have incurred annual operating losses. We expect this trend to continue until such time that we can sell a
sufficient number of units and achieve a cost structure to become profitable. Our business is such that we have relatively few customers and limited repeat business. As a result, we may not maintain
or increase revenue. We may not have adequate cash resources to reach the point of profitability, and we may never become profitable. Even if we do achieve profitability, we may be unable to increase
our sales and sustain or increase our profitability in the future.

We may be unable to fund our future operating requirements, which could force us to curtail our operations.

To the extent that the funds we now have on hand are insufficient to fund our future operating requirements, we would need to raise
additional funds, through further public or private equity or debt financings depending upon prevailing market conditions. These financings may not be available or, if available, may be on terms that
are not favorable to us and could result in dilution to our stockholders and reduction of the trading price of our stock. The state of worldwide capital markets could also impede our ability to raise
additional capital on favorable terms or at all. If adequate capital were not available to us, we likely would be required to significantly curtail our operations or possibly even cease our
operations.

We
maintain two Credit and Security Agreements, or the Agreements, with Wells Fargo Bank, National Association, ("Wells Fargo"), that provide us with a credit facility up to
$15.0 million in the aggregate. At March 31, 2013, we had $13.5 million outstanding under this line of credit. Under this credit facility, we are required to satisfy specified
financial and restrictive covenants. Failure to comply with these covenants could cause an event of default which, if not cured or waived, could require us to repay substantial indebtedness
immediately or allow Wells Fargo to terminate the credit facility. In addition, we have pledged our accounts receivable, inventories, equipment, patents and other assets as collateral under the
Agreements which would be subject to seizure by Wells Fargo if we were in default and unable to repay the indebtedness.

Several
times since entering into the Agreements, we have not been in compliance with certain covenants under the Agreements. In connection with each event of noncompliance, Wells Fargo
waived the event of default and, on several occasions, we amended the Agreements in response to the default. If we had not obtained the default waivers, or if we are ever again in noncompliance, we
would not be able to draw additional funds under the credit facility. The Agreement also defines an event of default to include a material adverse effect on our business, as determined by Wells Fargo.
An event of default for this or any other reason, if not waived, would have a material adverse effect on the Company.

Our
obligations under the credit facility could have important consequences, including the following:



We may have difficulty obtaining additional financing at favorable interest rates to meet our requirements for operations,
capital expenditures, general corporate or other purposes.



We will be required to dedicate a substantial portion of our cash flow to the payment of principal and interest on
indebtedness, which will reduce the amount of funds available for operations, capital expenditures and future acquisitions.



We may be required to repay our indebtedness immediately if we default on any of the numerous financial or other
restrictive covenants contained in the Agreements. It is not certain whether we will have, or will be able to obtain, sufficient funds to make these accelerated payments. If any outstanding
indebtedness under the credit facility is accelerated, our assets may not be sufficient to repay such indebtedness.

For
more information, see the section below entitled "Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources."

If we are unable to either substantially improve our operating results or obtain additional financing, we may be unable to continue as a going concern.

Management believes that existing cash and cash equivalents are sufficient to meet the Company's cash needs for working capital and
capital expenditures for at least the next twelve months. Should we be unable to execute our plans to build sales and margins while controlling costs, we may be unable to continue as a going concern
on a longer term basis. In particular, we must generate positive cash flow from operations and net income and otherwise improve our results of operations substantially on a longer term basis. Our
available cash and proceeds from future financings, if any, that we may be able to obtain, may not be sufficient to fund our operating expenses, capital expenditures and other cash requirements. Any
such lack of funds would affect our ability to continue as a going concern. These events and circumstances could have a material adverse effect on our ability to raise additional capital and on the
market value of our common stock and our ability to maintain a credit facility acceptable to the Company. Moreover, should we experience a cash shortage that requires us to curtail or cease our
operations, or should we be unable to continue as a going concern, you could lose all or part of your investments in our securities.

Impairment charges on our long-lived assets, including intangible assets with finite lives would adversely affect our financial position and results of
operations.

We evaluate the carrying value of long-lived assets, including intangible assets with finite lives, for impairment whenever
events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. To determine whether impairment has occurred, we compare the undiscounted cash flows of the
long-lived asset group with its carrying value. The estimation of future cash flows requires significant estimates of factors that include future sales growth, gross margin performance,
including our estimates of reductions in our direct material costs, and reductions in operating expenses. If our sales growth, gross margin performance or other estimated operating results are not
achieved at or above our forecasted level, or inflation exceeds our forecast, the carrying value of our asset group may prove to be unrecoverable and we may incur impairment charges in the future. In
addition, significant and unanticipated changes in circumstances, such as significant adverse changes in business climate, unanticipated competition, loss of key customers or changes in technology or
markets, could require a charge for impairment that can materially and adversely affect our reported net loss and our stockholders' equity.

A sustainable market for microturbines may never develop or may take longer to develop than we anticipate which would adversely affect our results of operations.

Our products represent an emerging market, and we do not know whether our targeted customers will accept our technology or will
purchase our products in sufficient quantities to allow our business to grow. To succeed, demand for our products must increase significantly in existing markets, and there must be strong demand for
products that we introduce in the future. If a sustainable market fails to develop or develops more slowly than we anticipate, we may be unable to recover the losses we have incurred to develop our
products, we may have further impairment of assets, and we may be unable to meet our operational expenses. The development of a sustainable market for our systems may be hindered by many factors,
including some that are out of our control. Examples include:



consumer reluctance to try a new product;



regulatory requirements;



the cost competitiveness of our microturbines;



costs associated with the installation and commissioning of our microturbines;



maintenance and repair costs associated with our microturbines;



the future costs and availability of fuels used by our microturbines;



economic downturns and reduction in capital spending;



consumer perceptions of our microturbines' safety and quality;



the emergence of newer, more competitive technologies and products; and



decrease in domestic and international incentives.

Our operating results are dependent, in large part, upon the successful commercialization of our products. Failure to produce our products as scheduled and budgeted would
materially and adversely affect our business and financial condition.

We cannot be certain that we will deliver ordered products in a timely manner. Any reliability or quality issues that may arise with
our products could prevent or delay scheduled deliveries. Any such delays or costs could significantly impact our business, financial condition and operating results.

We may not be able to produce our products on a timely basis if we fail to correctly anticipate product supply requirements or if we suffer delays in production resulting
from issues with our suppliers. Our suppliers may not supply us with a sufficient amount of components or components of adequate quality, or they may provide components at significantly increased
prices.

Some of our components are currently available only from a single source or limited sources. We may experience delays in production if
we fail to identify alternative suppliers, or if any parts supply is interrupted, each of which could materially adversely affect our business and operations. In order to reduce manufacturing lead
times and ensure adequate component supply, we enter into agreements with certain suppliers that allow them to procure inventories based upon criteria defined by us. If we fail to anticipate customer
demand properly, an oversupply of parts could result in excess or obsolete inventories, which could adversely affect our business. Additionally, if we fail to correctly anticipate our internal supply
requirements, an undersupply of parts could limit our production capacity. Our inability to meet volume commitments with suppliers could affect the
availability or pricing of our parts and components. A reduction or interruption in supply, a significant increase in price of one or more components or a decrease in demand of products could
materially adversely affect our business and operations and could materially damage our customer relationships. Financial problems of suppliers on

whom
we rely could limit our supply of components or increase our costs. Also, we cannot guarantee that any of the parts or components that we purchase will be of adequate quality or that the prices
we pay for the parts or components will not increase. Inadequate quality of products from suppliers could interrupt our ability to supply quality products to our customers in a timely manner.
Additionally, defects in materials or products supplied by our suppliers that are not identified before our products are placed in service by our customers could result in higher warranty costs and
damage to our reputation. We also outsource certain of our components internationally and expect to increase international outsourcing of components. As a result of outsourcing internationally, we may
be subject to delays in delivery because of regulations associated with the import/export process, delays in transportation or regional instability.

We may not be able to effectively manage our growth, expand our production capabilities or improve our operational, financial and management information systems, which would
impair our results of operations.

If we are successful in executing our business plan, we will experience growth in our business that could place a significant strain on
our business operations, management and other resources. Our ability to manage our growth will require us to expand our production capabilities, continue to improve our operational, financial and
management information systems, and to motivate and effectively manage our employees. We cannot provide assurance that our systems, procedures and controls or financial resources will be adequate, or
that our management will keep pace with this growth. We cannot provide assurance that our management will be able to manage this growth effectively.

Current economic conditions may have an impact on our business and financial condition, including some effects we may not be able to predict.

Current economic conditions may prevent our customers from purchasing our products or delay their purchases, which would adversely
affect our business, financial condition and results of operations. In addition, our ability to access the capital markets may be severely restricted or made very expensive at a time when we need, or
would like, to do so, which could have a
material adverse impact on our liquidity and financial resources. Certain industries in which our customers do business and certain geographic areas have been and could continue to be adversely
affected by the continued recession in economic activity. For example, we have encountered some recent slowing of sales activity in Europe and are discussing with certain of our European distributors
the availability of external financing for the purchase of our products. Continued financial instability there could have an adverse effect on our business.

In order to achieve our goal of improving the quality and lowering the total costs of ownership of our products, we may require
engineering changes. Such improvement initiatives may render existing inventories obsolete or excessive. Despite our continuous quality improvement initiatives, we may not meet customer expectations.
Any significant quality issues with our products could have a material adverse effect on our rate of product adoption, results of operations, financial condition and cash flow. Moreover, as we develop
new configurations for our microturbines and as our customers place existing configurations in commercial use, our products may perform below expectations. Any significant performance below
expectations could adversely affect our operating results, financial condition and cash flow and affect the marketability of our products.

We
sell our products with warranties. There can be no assurance that the provision for estimated product warranty will be sufficient to cover our warranty expenses in the future. We
cannot ensure that our efforts to reduce our risk through warranty disclaimers will effectively limit our liability. Any significant incurrence of warranty expense in excess of estimates could have a
material adverse effect on our operating results, financial condition and cash flow. Further, we have at times undertaken

programs
to enhance the performance of units previously sold. These enhancements have at times been provided at no cost or below our cost. If we choose to offer such programs again in the future, such
actions could result in significant costs.

We operate in a highly competitive market among competitors who have significantly greater resources than we have and we may not be able to compete effectively.

Capstone microturbines compete with several technologies, including reciprocating engines, fuel cells and solar power. Competing
technologies may receive certain benefits, like governmental subsidies or promotion, or be able to offer consumer rebates or other incentives that we cannot receive or offer to the same extent. This
could enhance our competitors' abilities to fund research, penetrate markets or increase sales. We also compete with other manufacturers of microturbines.

Our
competitors include several well-known companies with histories of providing power solutions. They have substantially greater resources than we have and have established
worldwide presence. Because of greater resources, some of our competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements, to devote greater
resources to the promotion and sale of their products than we can or lobby for governmental regulations and policies to create competitive advantages vis-à-vis
our products. We believe that developing and maintaining a competitive advantage will require continued investment by us in product development and quality, as well as attention to product
performance, our product prices, our conformance to industry standards, manufacturing capability and sales and marketing. In addition, current and potential competitors have established or may in the
future establish collaborative relationships among themselves or with third parties, including third parties with whom we have business relationships. Accordingly, new competitors or alliances may
emerge and rapidly acquire significant market share.

Overall,
the market for our products is highly competitive and is changing rapidly. We believe that the primary competitive factors affecting the market for our products, including some
that are outside of our control, include:



name recognition, historical performance and market power of our competitors;



product quality and performance;



operating efficiency;



product price;



availability, price and compatibility of fuel;



development of new products and features; and



emissions levels.

There
is no assurance that we will be able to successfully compete against either current or potential competitors or that competition will not have a material adverse effect on our
business, operating results, financial condition and cash flow.

If we do not effectively implement our sales, marketing and service plans, our sales will not grow and our results of operations will suffer.

Our sales and marketing efforts may not achieve intended results and, therefore, may not generate the revenue we anticipate. As a
result of our corporate strategies, we have decided to focus our resources on selected vertical markets. We may change our focus to other markets or applications in the future. There can be no
assurance that our focus or our near term plans will be successful. If we are not able to address markets for our products successfully, we may not be able to grow our business, compete effectively or
achieve profitability.

Our sales and results of operations could be materially and adversely impacted by risks inherent in international markets.

As we expand in international markets, customers may have difficulty or be unable to integrate our products into their existing systems
or may have difficulty complying with foreign regulatory and commercial requirements. As a result, our products may require redesign. Any redesign of the product may delay sales or cause quality
issues. In addition, we may be subject to a variety of other risks associated with international business, including import/export restrictions, fluctuations in currency exchange rates and global
economic or political instability. Two of our top distributors are located in Russia and Belgium, and therefore we are particularly susceptible to risks associated with doing business in these two
countries.

We cannot be certain of the future effectiveness of our internal controls over financial reporting or the impact thereof on our operations or the market price of our common
stock.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we are required to include in our Annual Reports on
Form 10-K our assessment of the
effectiveness of our internal controls over financial reporting. We cannot be certain that our internal controls over financial reporting will remain effective or that future material changes to our
internal controls will be effective. If we cannot adequately maintain the effectiveness of our internal controls over financial reporting, we might be subject to sanctions or investigation by
regulatory authorities, such as the SEC. Any such action could adversely affect our financial results and the market price of our securities.

We may not be able to retain or develop relationships with OEMs or distributors in our targeted markets, in which case our sales would not increase as expected.

In order to serve certain of our targeted markets, we believe that we must ally ourselves with companies that have particular expertise
or better access to those markets. We believe that retaining or developing relationships with strong OEMs (which to date have typically resold our products under their own brands or packaged
our products with other products as part of an integrated unit) or distributors in these targeted markets can improve the rate of adoption as well as reduce the direct financial burden of introducing
a new technology and creating a new market. Because of OEMs' and distributors' relationships in their respective markets, the loss of an OEM or distributor could adversely impact the ability to
penetrate our target markets. We offer our OEMs and distributors stated discounts from list price for the products they purchase. In the future, to attract and retain OEMs and
distributors we may provide volume price discounts or otherwise incur significant costs that may reduce the potential revenues from these relationships. We may not be able to retain or develop
appropriate OEMs and distributors on a timely basis, and we cannot provide assurance that the OEMs and distributors will focus adequate resources on selling our products or will be
successful in selling them. In addition, some of the relationships may require that we grant exclusive distribution rights in defined territories. These exclusive distribution arrangements could
result in our being unable to enter into other arrangements at a time when the OEM or distributor with whom we form a relationship is not successful in selling our products or has reduced its
commitment to market our products. We cannot provide assurance that we will be able to negotiate collaborative relationships on favorable terms or at all. Our inability to have appropriate
distribution in our target markets may adversely affect our financial condition, results of operations and cash flow.

Activities necessary to integrate any future acquisitions may result in costs in excess of current expectations or be less successful than anticipated.

During Fiscal 2010, we completed the acquisition of certain assets relating to the microturbine business of CPS, and we may acquire
other businesses in the future. The success of these transactions will depend on, among other things, our ability to develop productive relationships with the

corresponding
distributors and to integrate assets and personnel, if any, acquired in these transactions and to apply our internal controls processes to these acquired businesses. The integration of
any acquired businesses or significant assets may require significant attention from our management, and the diversion of management's attention and resources could have a material adverse effect on
our ability to manage our business. Furthermore, we may not realize the degree or timing of benefits we anticipated when we first enter into these transactions. If actual integration costs are higher
than amounts assumed, if we are unable to integrate the assets and personnel acquired in an acquisition as anticipated, or if we are unable to fully benefit from anticipated synergies, our business,
financial condition, results of operations, and cash flows could be materially adversely affected.

We have substantial accounts receivable, and increased bad debt expense or delays in collecting accounts receivable could have a material adverse effect on our cash flows
and results of operations.

Our accounts receivable balance, net of allowance for doubtful accounts, was $17.9 million and $18.6 million as of
March 31, 2013 and March 31, 2012, respectively. Days sales outstanding in accounts receivable (DSO) at the end of Fiscal 2013 was 46 days, compared with 56 days at the end
of Fiscal 2012. We recorded bad debt expense of $0.3 million and $2.3 million during Fiscal 2013 and 2012, respectively. No assurances can be given that future bad debt expense will not
increase above current operating levels. Increased bad debt expense or delays in collecting accounts receivable could have a material adverse effect on cash flows and results of operations.

Loss of a significant customer could have a material adverse effect on our results of operations.

Horizon and BPC accounted for approximately 27% and 11%, respectively, of our revenue for the fiscal year ended March 31, 2013.
As of March 31, 2013, BPC and Horizon represented 35% and 7% of net accounts receivable, respectively. Loss of Horizon, BPC or any other significant customers could adversely affect our results
of operations.

We may not be able to develop sufficiently trained applications engineering, installation and service support to serve our targeted markets.

Our ability to identify and develop business relationships with companies who can provide quality, cost-effective
application engineering, installation and service can significantly affect our success. The application engineering and proper installation of our microturbines, as well as proper maintenance and
service, are critical to the performance of the units. Additionally, we need to reduce the total installed cost of our microturbines to enhance market opportunities. Our inability to improve the
quality of applications, installation and service while reducing associated costs could affect the marketability of our products.

Changes in our product components may require us to replace parts held at distributors.

We have entered into agreements with some of our distributors requiring that if we render parts obsolete in inventories they own and
hold in support of their obligations to serve fielded microturbines, we are required to replace the affected stock at no cost to the distributors. It is possible that future changes in our product
technology could involve costs that have a material adverse effect on our results of operations, cash flow or financial position.

We operate in a highly regulated business environment, and changes in regulation could impose significant costs on us or make our products less economical, thereby affecting
demand for our microturbines.

Our products are subject to federal, state, local and foreign laws and regulations, governing, among other things, emissions and
occupational health and safety. Regulatory agencies may impose special requirements for the implementation and operation of our products or that may significantly affect or

even
eliminate some of our target markets. We may incur material costs or liabilities in complying with government regulations. In addition, potentially significant expenditures could be required in
order to comply with evolving environmental and health and safety laws, regulations and requirements that may be adopted or imposed in the future. Furthermore, our potential utility customers must
comply with
numerous laws and regulations. The deregulation of the utility industry may also create challenges for our marketing efforts. For example, as part of electric utility deregulation, federal, state and
local governmental authorities may impose transitional charges or exit fees, which would make it less economical for some potential customers to switch to our products. We can provide no assurances
that we will be able to obtain these approvals and changes in a timely manner, or at all. Non-compliance with applicable regulations could have a material adverse effect on our operating
results.

The
market for electricity and generation products is heavily influenced by federal and state government regulations and policies. The deregulation and restructuring of the electric
industry in the United States and elsewhere may cause rule changes that may reduce or eliminate some of the advantages of such deregulation and restructuring. We cannot determine how any deregulation
or restructuring of the electric utility industry may ultimately affect the market for our microturbines. Changes in regulatory standards or policies could reduce the level of investment in the
research and development of alternative power sources, including microturbines. Any reduction or termination of such programs could increase the cost to our potential customers, making our systems
less desirable, and thereby adversely affect our revenue and other operating results.

Utility companies or governmental entities could place barriers to our entry into the marketplace, and we may not be able to effectively sell our products.

Utility companies or governmental entities could place barriers on the installation of our products or the interconnection of the
products with the electric grid. Further, they may charge additional fees to customers who install on-site generation or have the capacity to use power from the grid for
back-up or standby purposes. These types of restrictions, fees or charges could hamper the ability to install or effectively use our products or increase the cost to our potential
customers for using our systems. This could make our systems less desirable, thereby adversely affecting our revenue and other operating results. In addition, utility rate reductions can make our
products less competitive which would have a material adverse effect on our operations. The cost of electric power generation bears a close relationship to natural gas and other fuels. However,
changes to electric utility tariffs often require lengthy regulatory approval and include a mix of fuel types as well as customer categories. Potential customers may perceive the resulting swings in
natural gas and electric pricing as an increased risk of investing in on-site generation.

We depend upon the development of new products and enhancements of existing products.

Our operating results depend on our ability to develop and introduce new products, enhance existing products and reduce the costs to
produce our products. The success of our products is dependent on several factors, including proper product definition, product cost, timely completion and introduction of the products,
differentiation of products from those of our competitors, meeting changing customer requirements, emerging industry standards and market acceptance of these
products. The development of new, technologically advanced products and enhancements is a complex and uncertain process requiring high levels of innovation, as well as the accurate anticipation of
technological and market trends. There can be no assurance that we will successfully identify new product opportunities, develop and bring new or enhanced products to market in a timely manner,
successfully lower costs and achieve market acceptance of our products, or that products and technologies developed by others will not render our products or technologies obsolete or noncompetitive.

Operational restructuring may result in asset impairment or other unanticipated charges.

As a result of our corporate strategy, we have identified opportunities to outsource to third-party suppliers certain functions which
we currently perform. We believe outsourcing can reduce product costs, improve product quality and increase operating efficiency. These actions may not yield the expected results, and outsourcing may
result in production delays or lower quality products. Transitioning to outsourcing may cause certain of our affected employees to leave before the outsourcing is complete. This could result in a lack
of the experienced in-house talent necessary to successfully implement the outsourcing. Further, depending on the nature of operations outsourced and the structure of agreements we reach
with suppliers to perform these functions, we may experience impairment in the value of manufacturing assets related to the outsourced functions or other unanticipated charges, which could have a
material adverse effect on our operating results.

We may not achieve production cost reductions necessary to competitively price our products, which would adversely affect our sales.

We believe that we will need to reduce the unit production cost of our products over time to maintain our ability to offer
competitively priced products. Our ability to achieve cost reductions will depend on our ability to develop low cost design enhancements, to obtain necessary tooling and favorable supplier contracts
and to increase sales volumes so we can achieve economies of scale. We cannot provide assurance that we will be able to achieve any such production cost reductions. Our failure to achieve such cost
reductions could have a material adverse effect on our business and results of operations.

Our products contain a number of commodity materials from metals, which include steel, special high temperature alloys, copper, nickel
and molybdenum, to computer components. The availability of these commodities could impact our ability to acquire the materials necessary to meet our production requirements. The cost of metals has
historically fluctuated. The pricing could impact the costs to manufacture our products. If we are not able to acquire commodity materials at prices and on terms satisfactory to us or at all, our
operating results may be materially adversely affected.

Our products involve a lengthy sales cycle and we may not anticipate sales levels appropriately, which could impair our results of operations.

The sale of our products typically involves a significant commitment of capital by customers, with the attendant delays frequently
associated with large capital expenditures. For these and other reasons, the sales cycle associated with our products is typically lengthy and subject to a number of significant risks over which we
have little or no control. We expect to plan our production and inventory levels based on internal forecasts of customer demand, which is highly unpredictable and can fluctuate substantially. If sales
in any period fall significantly below anticipated levels, our financial condition, results of operations and cash flow would suffer. If demand in any period increases well above anticipated levels,
we may have difficulties in responding, incur greater costs to respond, or be unable to fulfill the demand in sufficient time to retain the order, which would negatively impact our operations. In
addition, our operating expenses are based on anticipated sales levels, and a high percentage of our expenses are generally fixed in the short term. As a result of these factors, a small fluctuation
in timing of sales can cause operating results to vary materially from period to period.

Potential litigation may adversely impact our business.

We may face litigation relating to labor matters or other matters. Any litigation could be costly, divert management attention or
result in increased costs of doing business.

Our business could be negatively impacted if we fail to adequately protect our intellectual property rights or if third parties claim that we are in violation of their
intellectual property rights.

We view our intellectual property rights as important assets. We seek to protect our intellectual property rights through a combination
of patent, trademark, copyright and trade secret laws, as well as licensing and confidentiality agreements. These protections may not be adequate to prevent third parties from using our intellectual
property without our authorization, breaching any confidentiality agreements with us, copying or reverse engineering our products, or developing and marketing products that are substantially
equivalent to or superior to our own. The unauthorized use of our intellectual property by others could reduce our competitive advantage and harm our business. If it became necessary for us to
litigate to protect these rights, any proceedings could be burdensome and costly and we may not prevail. We cannot guarantee that any patents, issued or pending, will provide us with any competitive
advantage or will not be challenged by third parties. Moreover, the expiration of our patents may lead to increased competition with respect to certain products. In addition, we cannot be certain that
we do not or will not infringe third parties' intellectual property rights. Any such claim, even if it is without merit, may be expensive and time-consuming to defend, subject us to
damages, cause us to cease making, using or selling certain products that incorporate the disputed intellectual property, require us to redesign our products, divert management time and attention
and/or require us to enter into costly royalty or licensing arrangements.

Our results of operations could be materially and adversely affected by risks related to cyber security threats.

As a manufacturer of high technology commercial products, we face cyber security threats, as well as the potential for business
disruptions associated with information technology failures or cyber security attacks. We routinely experience cyber security threats, threats to our information technology infrastructure and attempts
to gain access to our sensitive information. Because of the evolving nature of these security threats, the impact of any future incident cannot be predicted. The occurrence of any of these events
could adversely affect our results of operations, the services we provide to customers, the competitive advantages derived from our R&D efforts, the usefulness of our products and services, our
reputation or our stock price.

We may incur costs and liabilities as a result of product liability claims.

We face a risk of exposure to product liability claims in the event that the use of our products is alleged to have resulted in injury
or other damage. Although we currently maintain product liability insurance coverage, we may not be able to obtain such insurance on acceptable terms in the future, if at all, or obtain insurance that
will provide adequate coverage against potential claims. Product liability claims can be expensive to defend and can divert the attention of management and other personnel for long periods of time,
regardless of the ultimate outcome. A significant unsuccessful product liability defense could have a material adverse effect on our financial
condition and results of operations. In addition, we believe our business depends on the strong brand reputation we have developed. If our reputation is damaged, we may face difficulty in maintaining
our market share and pricing with respect to some of our products, which could reduce our sales and profitability.

We have significant tax assets, usage of which may be subject to limitations in the future.

At March 31, 2013, we had federal and state net operating loss carryforwards of approximately $592.0 million and
$283.9 million, respectively, which may be utilized to reduce future taxable income, subject to limitations under Section 382 of the Internal Revenue Code of 1986. These deferred tax
assets have been fully offset by a valuation allowance. Any subsequent accumulations of common stock ownership leading to a change of control under Section 382 of the U.S. Internal Revenue Code
of 1986, including through sales of stock by large stockholders, all of which are outside of our control,

Our success depends in significant part upon the continuing service of management and key employees.

Our success depends in significant part upon the continuing service of our executive officers, senior management and sales and
technical personnel. The failure of our personnel to execute our strategy or our failure to retain management and personnel could have a material adverse effect on our business. Our success will be
dependent on our continued ability to attract, retain and motivate highly skilled employees. There can be no assurance that we can do so.

Our
internal control systems rely on people trained in the execution of the controls. Loss of these people or our inability to replace them with similarly skilled and trained individuals
or new processes in a timely manner could adversely impact our internal control mechanisms.

Our operations are vulnerable to interruption by fire, earthquake and other events beyond our control.

Our operations are vulnerable to interruption by fire, earthquake and other events beyond our control. Our executive offices and
manufacturing facilities are located in southern California. Because the southern California area is located in an earthquake-sensitive area, we are particularly susceptible to the risk of damage to,
or total destruction of, our facilities in southern California and the surrounding transportation infrastructure, which could affect our ability to make and transport our products. If an earthquake,
fire or other natural disaster occurs at or near our facilities, our business, financial condition, operating results and cash flow could be materially adversely affected.

If we fail to meet all applicable Nasdaq Global Market requirements and Nasdaq determines to delist our common stock, the delisting could adversely affect the market
liquidity of our common stock, impair the value of your investment and adversely affect our ability to raise needed funds.

Our common stock is listed on the Nasdaq Global Market. In order to maintain that listing, we must satisfy minimum financial and other
requirements. On December 21, 2012, we received a notice from the Nasdaq Listing Qualifications Department stating that, for the last 30 consecutive business days, the closing bid price for our
common stock had been below the minimum $1.00 per share requirement for continued listing on the Nasdaq Global Market as set forth in Nasdaq Listing Rule 5450(a)(1). In accordance with Nasdaq
Listing Rule 5810(c)(3)(A), we were provided 180 calendar days, or until June 19, 2013, to regain compliance with the minimum bid price requirement. On June 10, 2013, we received
a notice from the Nasdaq Listing Qualifications Department stating that the closing bid price of our common stock had been $1.00 or greater for the previous ten consecutive business days and that we
had regained compliance with the minimum bid price requirement. However, there can be no assurance that we will be able to comply with the continued listing standards in the future.

If
we fail to meet all applicable Nasdaq Global Market requirements in the future and Nasdaq determines to delist our common stock, the delisting could adversely affect the market
liquidity of our common stock and adversely affect our ability to obtain financing for the continuation of our operations. This delisting could also impair the value of your investment.

The market price of our common stock has been and may continue to be highly volatile and you could lose all or part of your investment in our securities.

An investment in our securities is risky, and stockholders could lose their investment in our securities or suffer significant losses
and wide fluctuations in the market value of their investment. The market price of our common stock is highly volatile and is likely to continue to
be highly volatile. Given the continued uncertainty surrounding many variables that may affect our business and the

industry
in which we operate, our ability to foresee results for future periods is limited. This variability could affect our operating results and thereby adversely affect our stock price. Many
factors that contribute to this volatility are beyond our control and may cause the market price of our common stock to change, regardless of our operating performance. Factors that could cause
fluctuation in our stock price may include, among other things:

changes in financial estimates or recommendations by securities analysts;



conditions or trends in our industry or the overall economy;



loss of one or more of our significant customers;



errors, omissions or failures by third parties in meeting commitments to us;



changes in the market valuations or earnings of our competitors or other technology companies;



the trading of options on our common stock;



announcements by us or our competitors of significant acquisitions, strategic partnerships, divestitures, joint ventures
or other strategic initiatives;



announcements of significant market events, such as power outages, regulatory changes or technology changes;



changes in the estimation of the future size and growth rate of our market;



future equity financings;



the failure to produce our products on a timely basis in accordance with customer expectations;



the inability to obtain necessary components on time and at a reasonable cost;



litigation or disputes with customers or business partners;



capital commitments;



additions or departures of key personnel;



sales or purchases of our common stock;



the trading volume of our common stock;



developments relating to litigation or governmental investigations; and



decreases in oil, natural gas and electricity prices.

In
addition, the stock market in general, and the Nasdaq Global Market and the market for technology companies in particular, have experienced extreme price and volume fluctuations that
have often been unrelated or disproportionate to the operating performance of particular companies affected. The market prices of securities of technology companies and companies servicing the
technology industries have been particularly volatile. These broad market and industry factors may cause a material decline in the market price of our common stock, regardless of our operating
performance. In the past, following periods of volatility in the market price of a company's securities, securities classaction litigation has often been instituted against that company.
This type of litigation, regardless of whether we prevail on the underlying claim, could result in substantial costs and a diversion of management's attention and resources, which could materially
harm our financial condition, results of operations and cash flow.

Provisions in our certificate of incorporation, bylaws and our stockholder rights plan, as well as Delaware law, may discourage, delay or prevent a merger or acquisition at
a premium price.

Provisions of our second amended and restated certificate of incorporation, amended and restated bylaws and our stockholder rights
plan, as well as provisions of the General Corporation Law of the State of Delaware, could discourage, delay or prevent unsolicited proposals to merge with or acquire us, even though such proposals
may be at a premium price or otherwise beneficial to you. These provisions include our board's authorization to issue shares of preferred stock, on terms the board determines in its discretion,
without stockholder approval, and the following provisions of Delaware law that restrict many business combinations.

We
are subject to the provisions of Section 203 of the General Corporation Law of the State of Delaware, which could prevent us from engaging in a business combination with a 15%
or greater stockholder for a period of three years from the date such stockholder acquired such status unless appropriate board or stockholder approvals are obtained.

Our
board of directors has adopted a stockholder rights plan, pursuant to which one preferred stock purchase right has been issued for each share of our common stock authorized and
outstanding. Until the occurrence of certain prescribed events, the rights are not exercisable and are transferable along with, and only with, each share of our common stock and are evidenced by the
common stock certificates. One preferred stock purchase right will also be issued with each share of our common stock we issue in the future until the rights plan expires or is terminated or we redeem
or exchange the rights for other property in accordance with the terms of the rights plan or at such time, if any, as the rights separate from each share of our common stock and become exercisable.
Each share of Series A Junior Participating Preferred Stock will be entitled to receive, when, as and if declared by our board of directors out of funds legally available for the purpose,
dividends payable in cash in an amount per share (rounded to the nearest cent) equal to 100 times the aggregate per share amount of all dividends or other distributions, including non-cash
dividends (payable in kind), declared on our common stock other than a dividend payable in shares of common stock or a subdivision of the outstanding shares of common stock. The rights plan prohibits
the issuance of additional rights after the rights separate from our common stock. The rights plan is intended to protect our stockholders in the event of an unfair or coercive offer to acquire us.
However, the existence of the rights plan may discourage, delay or prevent a merger or acquisition of us that is not supported by our board of directors.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

Our principal corporate offices, administrative, sales and marketing, R&D and support facilities consist of approximately 98,000 square
feet of leased office space, warehouse space and assembly and test space located at 21211 Nordhoff Street in Chatsworth, California. Our lease for those premises expires in July 2014, and we have two
five-year options to extend the term of this lease. We also lease an approximately 79,000 square foot facility at 16640 Stagg Street in Van Nuys, California as an engineering test and
manufacturing facility for our recuperator cores. This lease will expire in December 2017. Management believes our facilities are adequate for our current needs.

Item 3. Legal Proceedings.

From time to time, the Company may become subject to certain legal proceedings, claims and litigation arising in the ordinary course of
business. In the opinion of management, we are not a party to any other material legal proceedings, nor are we aware of any other pending or threatened litigation

Our common stock is publicly traded on the Nasdaq Global Market under the symbol "CPST". The following table sets forth the low and
high sales prices for each period indicated.

High

Low

Year Ended March 31, 2012:

First Quarter

$

2.07

$

1.30

Second Quarter

$

1.69

$

0.99

Third Quarter

$

1.29

$

0.85

Fourth Quarter

$

1.53

$

0.98

Year Ended March 31, 2013:

First Quarter

$

1.20

$

0.93

Second Quarter

$

1.13

$

0.98

Third Quarter

$

1.06

$

0.87

Fourth Quarter

$

1.06

$

0.73

As
of June 6, 2013, the last reported sale price of our common stock on the Nasdaq Global Market was $1.19 per share.

Stockholders

As of June 6, 2013, there were 667 stockholders of record of our common stock. This does not include the number of persons whose
stock is held in nominee or "street name" accounts through brokers.

Dividend Policy

We currently intend to retain any earnings for use in our business and, therefore, we do not anticipate paying any cash dividends in
the foreseeable future. We have never declared or paid any cash dividends on our capital stock. In the future, the decision to pay any cash dividends will depend upon our results of operations,
financial condition, cash flow and capital expenditure plans, as well as such other factors as our Board of Directors, in its sole discretion, may consider relevant, including approval from Wells
Fargo.

The selected financial data shown below have been derived from the audited financial statements of Capstone. The historical results are
not necessarily indicative of the operating results to be expected in the future. The selected financial data should be read in conjunction with "Risk Factors," "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and the consolidated financial statements and related notes included elsewhere in this Annual Report.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains
forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause a
difference include, but are not limited to, those discussed under Item 1A (Risk Factors) in this Annual Report. The following section is qualified in its entirety by the more detailed
information, including our financial statements and the notes thereto, which appears elsewhere in this Annual Report.

Overview

Capstone is the market leader in microturbines based on the number of microturbines sold. We increased revenues during Fiscal 2013
compared to Fiscal 2012 despite the challenging economic conditions worldwide. Management believes that our ongoing efforts to grow and broaden our distribution network along with continued market
acceptance of our 200 kW ("C200") microturbine and 1000 kW ("C1000 Series") microturbines products were the primary reasons for our revenue growth during the year compared to Fiscal 2012. Fiscal 2013
was characterized by strong demand for C200 and C1000 Series microturbines led by the North American natural resources vertical market, while weakness continued in the European market as a result of
uncertain global economic conditions. Domestic demand was strong; sales from our U.S.based distributors during Fiscal 2013 were 45% of total revenue compared to 38% of total revenue
during Fiscal 2012. Management believes that sales in the natural resources vertical market will continue to grow and also expects the European market for our products will begin to recover during
Fiscal 2014. During Fiscal 2013 we received approximately 22 significant orders totaling approximately 54.4 megawatts, continued to make progress in manufacturing cost reduction and had record sales,
continuing overall progress on our path to profitability. In addition, we continue to make progress on our C250 product development initiative. During Fiscal 2013, we experienced a higher rate of
warranty claims than expected for C200 and C1000 Series systems. Management expects warranty claims levels for C200 and C1000 Series systems to decline during Fiscal 2014 as reliability repair
programs are completed and the products mature.

Capstone
products continue to gain interest in all five of the major vertical markets (energy efficiency, renewable energy, natural resources, critical power supply and transportation
products). In the energy efficiency market, we continue to expand our market share in hotels, office buildings, hospitals, retail and industrial applications globally. The renewable energy market
continues to be a significant portion of our business as we shipped products around the globe for applications fueled by landfill gas, biodiesel, biogas such as food processing and agricultural waste,
referred to as green waste, and cow, pig and chicken manure. Our C1000 Series microturbine continues to drive our near term business success in the oil and gas and other natural resource markets as we
gain product acceptance in U.S. shale plays and Russian oil fields. Our critical power supply data center product is performing well, and we continue to focus efforts on gaining market share with this
new product. Capstone's transportation products market, utilizing microturbines for electric vehicles, is gaining interest for use of our products as range extenders in electric buses, trucks and the
marine industry.

We
continue to focus on improving our products based on customer input, building brand awareness and new channels to market by developing a diversified network of strategic distribution
partners. Our focus is on products and solutions that provide near-term opportunities to drive repeatable business rather than discrete projects for niche markets. In addition, management
closely manages operating expenses and strives to improve manufacturing efficiencies while simultaneously lowering direct material costs and increasing average selling prices. The key drivers to
Capstone's success are continued increase in C200 microturbine engine production rates, higher average selling prices, lower direct material costs, positive new order flow and reduced cash usage.

On
February 1, 2010, we entered into an asset purchase agreement ("APA") with Calnetix Power Solutions, Inc. ("CPS") pursuant to which we acquired, subject to an existing
license retained by CPS, all of the rights and assets related to the manufacture and sale of the 100 kW ("TA100") microturbine generator, including intellectual property, design, tooling, drawings,
patents, know-how, distribution agreements and supply agreements. Pursuant to the APA, the Company issued to CPS 1,550,387 shares of common stock at the closing date on February 1,
2010 and agreed to pay additional consideration of $3.1 million on July 30, 2010 (the "Second Funding Date"). The additional consideration was to be paid, at the Company's discretion, in
shares of the Company's common stock or cash. The Company elected to satisfy the amount due on the Second Funding Date with common stock and issued 3,131,313 shares to CPS.

To
support our opportunities to grow in our targeted markets, we continue to enhance the reliability and performance of our products by regularly developing new processes and enhancing
training to assist those who apply, install and use our products.

An
overview of our direction, targets and key initiatives follows:

1)

Focus on Vertical Markets Within the distributed generation markets that we serve, we focus on
vertical markets that we identify as having the greatest near-term potential. In our primary products and applications (energy efficiency, renewable energy, natural resources, critical
power supply and mobile products), we identify specific targeted vertical market segments. Within each of these segments, we identify what we believe to be the critical factors to success and base our
plans on those factors.

During
Fiscal 2013, we booked orders for 107.2 megawatts and shipped 103.2 megawatts of products, which combined with our backlog at March 31, 2012, resulted in 162.8 megawatts in backlog at
the end of the fiscal year. Our product shipments in Fiscal 2013 were: 55% for use in natural resources applications, 25% for use in energy efficiency applications, 6% for use in renewable energy
applications and 14% for use in other applications (including critical power supply and mobile products).

Energy EfficiencyCHP/CCHP

Energy
efficiency maximizes the use of energy produced by the microturbines, reduces emissions compared with traditional power generation and enhances the economic advantage to customers. Energy
efficiency applications use both the heat and electric energy produced in the power generation process. Using the heat and electricity created from a single combustion process increases the efficiency
of the system from approximately 30% to 75% or more. The increased operating efficiency reduces overall greenhouse gas emissions compared with traditional independent sources such as power generation
and local thermal generation and, through displacement of other separate systems, can reduce variable production costs.

Renewable Energy

Our
microturbines can use renewable methane gases from landfills, wastewater treatment facilities and other biogas applications such as food processing and agricultural waste, referred to as green
waste, and cow, pig and chicken manure. Capstone's microturbines can burn these renewable waste gases with minimal emissions, thereby, in some cases, avoiding the imposition of penalties incurred for
pollution while simultaneously producing electricity from this "free" renewable fuel for use at the site or in the surrounding area. Capstone's microturbines have

demonstrated
effectiveness in these applications and outperform conventional combustion engines in a number of situations, including when the gas contains a high amount of sulfur.

Natural ResourcesOil, Natural Gas, Shale Gas & Mining

On
a worldwide basis, there are thousands of locations where the drilling, production, compression and transportation of natural resources and other extraction and production processes create fuel
byproducts, which traditionally have been released or burned into the atmosphere. Our microturbines are installed in the natural resource market to be used in oil and gas exploration, production,
compression and transmission sites both onshore and offshore as a highly reliable critical source of power generation. In addition, our microturbines can use flare gas as a fuel to provide prime
power. Typically these oil and gas or mining operations have no access to an electric utility grid and rely solely on Capstone's microturbines for a reliable low emission power supply.

Critical Power Supply

Because
of the potentially catastrophic consequences of even momentary system failure, certain power users, such as high technology and information systems companies, require particularly high levels
of reliability in their power service. Management believes that Capstone's critical power supply offerings are the world's only microturbine powered Uninterruptible Power Source solutions that can
offer clean, IT-grade power produced from microturbines, the utility or a combination of both.

Mobile ProductsHybrid Electric Vehicles

Our
technology is also used in hybrid electric vehicle applications. Our customers have applied our products in hybrid electric mobile applications, including transit buses and trucks. In these
applications the microturbine acts as an onboard battery charger to recharge the battery system as needed. The benefits of microturbine hybrids include extended range, fuel economy gains, quieter
operation, reduced emissions and higher reliability compared with traditional internal combustion engines.

Mobile ProductsMarine

Our
technology is also used in marine applications. Our customers have applied our products in the commercial vessel and luxury yacht markets. The most immediate market for our marine products is for
use as ship auxiliaries. In this application, the microturbines provide power to the vessel's electrical loads and, in some cases, the vessel is able to utilize the exhaust energy to increase the
overall efficiency of the application, reducing overall fuel consumption and emissions. The other application is similar to our HEV application where the vessel is driven by an electric propulsion
system and the microturbine serves as an on board range extender.

2)

Sales and Distribution Channel We seek out distributors that have business experience and
capabilities to support our growth plans in our targeted markets. We have a total of 91 distributors and Original Equipment Manufacturers ("OEMs"). In North America, we currently have 32
distributors and OEMs. Internationally, outside of North America, we currently have 59 distributors and OEMs. We continue to refine the distribution channels to address our specific
targeted markets.

3)

Service Service is provided primarily by our global distribution network. Together with our
global distribution network we offer new and remanufactured parts as well as a comprehensive FPP. Through our global distribution network, we offer a comprehensive FPP for a fixed

annual
fee to perform regularly scheduled and unscheduled maintenance as needed. In January 2011, we expanded the FPP to include total microturbine plant operations if required by the end use
customer. Capstone provides factory and onsite training to certify all personnel that are allowed to perform service on our microturbines. FPPs are generally paid quarterly in advance. Our FPP backlog
at the end of Fiscal 2013 was $35.0 million which represents the value of the contractual agreement for FPP services that has not been earned and extends through Fiscal 2028. Service revenue in
Fiscal 2013 was approximately 8% of total revenue.

4)

Product Robustness We continue to invest in enhancements that relate to high performance and
high reliability. An important element of our continued innovation and product strategy is to focus on the engineering of our product hardware and electronics to make them work together more
effectively and deliver improved microturbine performance, reliability and low maintenance cost to our customers.

5)

New Product Development Our new product development is targeted specifically to meet the needs
of our selected vertical markets. We expect that our existing product platforms, the C30, C65, TA100, C200 and C1000 Series microturbines, will be our foundational product lines for the foreseeable
future. Our research and development project portfolio is centered on enhancing the features of these base products. We are currently focusing efforts on enhancing our products to improve reliability,
reduce direct material costs, and be compliant with the new stringent European VDE power grid requirements. We are also developing a more efficient microturbine Combined Heat and Power ("CHP") system
with the DOE. The first phase of the development program has successfully achieved 270 kW with a prototype C250 engine. Capstone plans to continue development of the engine as well as power
electronics and software controls required for successful commercialization. The second phase of the program is expected to incorporate further engine efficiency improvements, resulting in a product
with a projected electrical efficiency of 42% and targeted power output of 370 kW. The DOE awarded us a grant of $5.0 million in support of this development program.

6)

Cost and Core Competencies We believe that the core competencies of Capstone products are
air-bearing technology, advanced combustion technology and sophisticated power electronics to form efficient and ultra-low emission electricity and cooling and heat production
systems. Our core intellectual property is contained within our air-bearing technology. We continue to review avenues for cost reduction by sourcing to the best value supply chain option.
In order to utilize manufacturing facilities and technology more effectively, we are focused on continuous improvements in manufacturing processes. Additionally, considerable effort is being directed
to manufacturing cost reduction through process improvement, product design, advanced manufacturing technology, supply management and logistics. Management expects to be able to leverage our costs as
product volumes increase.

Management
believes that effective execution in each of these key areas will be necessary to leverage Capstone's promising technology and early market leadership into achieving positive
cash flow with growing market presence and improving financial performance. Based on our recent progress and assuming achievement of targeted cost reductions, our financial model indicates that we
will achieve positive cash flow when we ship approximately 200 units in a quarter, depending on an assumed product mix. Management believes our manufacturing facilities located in Chatsworth and Van
Nuys, California have a combined production capacity of approximately 2,000 units per year, depending on product mix. Excluding working capital requirements, management believes we can expand our
combined production capacity to approximately 4,000 units per year, depending on product mix, with approximately $10 to $15 million of capital expenditures. We have not committed to this
expansion nor identified a source for its funding.

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these consolidated financial statements requires us to
make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosures of contingent liabilities. On an on-going basis, we
evaluate our estimates, including but not limited to those related to long-lived assets, including finite-lived intangible assets and fixed assets, bad debts, inventories, warranty
obligations, stock-based compensation, warrant liabilities, income taxes and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be
reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or conditions.

Management
believes that the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.



We evaluate the carrying value of long-lived assets, including intangible assets with finite lives, for
impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Factors that are considered important that could trigger an impairment
review include a current-period operating or cash flow loss combined with a history of operating or cash flow losses and a projection or forecast that demonstrates continuing losses or insufficient
income associated with the use of a long-lived asset or asset group. Other factors include a significant change in the manner of the use of the asset or a significant negative industry or
economic trend. This evaluation is performed based on undiscounted estimated future cash flows compared with the carrying value of the related assets. If the undiscounted estimated future cash flows
are less than the carrying value, an impairment loss is recognized and the loss is measured by the difference between the carrying value and the estimated fair value of the asset group. The estimated
fair value of the assets are determined using the best information available. On a quarterly basis, we assess whether events or changes in circumstances have occurred that potentially indicate the
carrying value of long-lived assets may not be recoverable. Intangible assets include a manufacturing license, technology, backlog and customer relationships. We reevaluate the useful life
determinations for these intangible assets each reporting period to determine whether events and circumstances warrant a revision in their remaining useful lives. The Company performed an analysis as
of March 31, 2013 and determined that no impairment was necessary. See Note 5Intangible Assets in the "Notes to Consolidated Financial Statements."



Our inventories are valued on a first in first out ("FIFO") basis and at the lower of cost or market. We routinely
evaluate the composition of our inventories and identify slow-moving, excess, obsolete or otherwise impaired inventories. Inventories identified as impaired are evaluated to determine if
write-downs are required. Included in this assessment is a review for obsolescence as a result of engineering changes in our product. Future product enhancement and development may render certain
inventories obsolete, resulting in additional write-downs of inventories. In addition, inventories are classified as current or long-term based on our sales forecast and also, in part,
based on our projected usage for warranty claims and service. A change in forecast could impact the classification of inventories.



We provide for the estimated cost of warranties at the time revenue from sales is recognized. We also accrue the estimated
costs to address reliability repairs on products no longer under warranty when, in our judgment, and in accordance with a specific plan developed by us, it is prudent to provide such repairs. We
estimate warranty expenses based upon historical and

projected
product failure rates, estimated costs of parts, labor and shipping to repair or replace a unit and the number of units covered under the warranty period. While we engage in extensive
quality programs and processes, our warranty obligation is affected by failure rates and service costs in correcting failures. As we have more units commissioned and longer periods of actual
performance, additional data becomes available to assess future warranty costs. When we have sufficient evidence that product changes are altering the historical failure occurrence rates, the impact
of such changes is then taken into account in estimating future warranty liabilities. Changes in estimates are recorded in the period that new information, such as design changes, cost of repair and
product enhancements, becomes available. Should actual failure rates or service costs differ from our estimates, revisions to the warranty liability would be required and could be material to our
financial condition, results of operations and cash flow.



Our revenue consists of sales of products, parts, accessories and service, which includes FPPs, net of discounts. Our
distributors purchase products, parts and FPPs for sale to end users and are also required to provide a variety of additional services, including application engineering, installation, commissioning
and post-commissioning service. Our standard terms of sales to distributors and direct end users include transfer of title, care, custody and control at the point of shipment, payment
terms ranging from full payment in advance of shipment to payment in 90 days, no right of return or exchange, and no post-shipment performance obligations by us except for
warranties provided on the products and parts sold. We recognize revenue when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or service has
been rendered, selling price is fixed or determinable and collectability is reasonably assured. Service revenue derived from time and materials contracts is recognized as the service is performed. FPP
contracts are agreements to perform certain agreed-upon service to maintain a product for a specified period of time. Service revenue derived from FPP contracts is recognized on a
straight-line basis over the contract period. We occasionally enter into agreements that contain multiple elements, such as equipment, installation, engineering and/or service.



We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make
required payments. We evaluate all accounts aged over 60 days or past payment terms. If the financial condition of our customers deteriorates or if other conditions arise that result in an
impairment of their ability or intention to make payments, additional allowances may be required.



We have a history of unprofitable operations. These losses generated significant federal and state net operating loss
("NOL") carryforwards. We record a valuation allowance against the net deferred income tax assets associated with these NOLs if it is "more likely than not" that we will not be able to
utilize them to offset future income taxes. Because of the uncertainty surrounding the timing of realizing the benefits of our favorable tax attributes in future income tax returns, a valuation
allowance has been provided against all of our net deferred income tax assets. We currently provide for income taxes only to the extent that we expect to pay cash taxes, primarily foreign and state
taxes. It is possible, however, that we could be profitable in the future at levels which could cause management to determine that it is more likely than not that we will realize all or a portion of
the NOL carryforwards. Upon reaching such a conclusion, we would record the estimated net realizable value of the deferred income tax asset at that time. Such adjustment would increase income in the
period that the determination was made.



We recognize stock-based compensation expense associated with stock options in the statement of operations. Determining
the amount of stock-based compensation to be recorded requires us to develop estimates to be used in calculating the grant-date fair value of stock options. We calculate the
grant-date fair values using the Black-Scholes valuation model.

The
use of Black-Scholes model requires us to make estimates of the following assumptions:



Expected volatilityThe estimated stock price volatility was
derived based upon the Company's actual historic stock prices over the expected option life, which represents the Company's best estimate of expected volatility.



Expected option lifeThe expected life, or term, of options
granted was derived from historical exercise behavior and represents the period of time that stock option awards are expected to be outstanding.



Risk-free interest rateWe used the yield on
zero-coupon U.S. Treasury securities for a period that is commensurate with the expected life assumption as the risk-free interest rate.

The
amount of stock-based compensation recognized during a period is based on the value of the portion of the awards that are ultimately expected to vest. We estimate forfeitures at the time of grant
and revise, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The term "forfeitures" is distinct from "cancellations" or "expirations" and represents only the
unvested portion of the surrendered option. We review historical forfeiture data and determine the appropriate forfeiture rate based on that data. We re-evaluate this analysis periodically
and adjust the forfeiture rate as necessary. Ultimately, we recognize the actual expense over the vesting period only for the shares that vest.



As discussed in Note 10Fair Value Measurements in the "Notes to Consolidated Financial Statements",
Accounting Standards Codification ("ASC") 815 requires that our warrants be accounted for as derivative instruments and that we mark the value of our warrant liability to market and recognize the
change in valuation in our statement of operations each reporting period. Determining the warrant liability to be recorded requires us to develop estimates to be used in calculating the fair value of
the warrants. We calculate the fair values using the Monte Carlo simulation model.

The
use of the Monte Carlo simulation model requires us to make estimates of the following assumptions:



Expected volatilityThe estimated stock price volatility was
derived based upon the Company's actual historic stock prices over the contractual life of the warrants, which represents the Company's best estimate of expected volatility.



Risk-free interest rateWe used the yield on
zero-coupon U.S. Treasury securities for a period that is commensurate with the warrant contractual life assumption as the risk-free interest rate.

Results of Operations

Year Ended March 31, 2013 Compared to Year Ended March 31, 2012

Revenue Revenue for Fiscal 2013 increased $18.2 million, or 17%, to $127.6 million from $109.4 million for Fiscal
2012. The
change in revenue for Fiscal 2013 compared to Fiscal 2012 included increases in revenue of $34.2 million from the North American market, $2.8 million from the Asian market,
$2.7 million from the Australian market and $0.7 million from the South American market. The increase in the North American market was primarily related to increased revenue in the U.S.
shale plays market. The increases in the Australian, Asian and South American markets were primarily the result of microturbine product sales to certain distributors that did not occur during the same
period last year. This overall increase in revenue was offset by decreases in revenue of $21.3 million from the European market and $0.9 million from the African market. We expect
revenue from the European market will continue to be soft as a result of general economic conditions. The decrease in

the
African market was primarily the result of non-recurring microturbine product sales in Fiscal 2012 to certain distributors that did not occur in Fiscal 2013.

For
Fiscal 2013, revenue from microturbine products increased $12.8 million, or 14%, to $102.7 million from $89.9 million for Fiscal 2012. Microturbine megawatts
shipped during Fiscal 2013 increased 7.1 megawatts, or 7%, to 103.2 megawatts from 96.1 megawatts for Fiscal 2012. Microturbine units shipped during Fiscal 2013 increased to 628 units from 627 units
for Fiscal 2012. Average revenue per unit increased for Fiscal 2013 to approximately $163,000 compared to approximately $143,000 per unit for Fiscal 2012. Megawatts shipped and revenue per unit during
Fiscal 2013 increased as a result of higher sales volume for our C30, TA100 and C200 systems and a change in product mix of the C1000 Series systems, offset by lower sales volume for our C65
microturbines.

For
Fiscal 2013, revenue from our accessories, parts and service increased $5.4 million, or 28%, to $24.9 million from $19.5 million for Fiscal 2012. The increase in
revenue resulted primarily from higher sales of microturbine parts and service work.

The
timing of shipments is subject to change based on several variables (including customer deposits, payments, availability of credit and delivery schedule changes), most of which are
not within our control and can affect the timing of our revenue. Therefore, we evaluate historical revenue in conjunction with backlog to anticipate the growth trend of our revenue.

The
following table summarizes our revenue (revenue amounts in millions):

Years Ended March 31,

2013

2012

Revenue

Megawatts

Units

Revenue

Megawatts

Units

C30

$

6.8

4.4

147

$

4.4

3.2

108

C65

22.9

21.0

323

28.7

26.9

414

TA100

1.5

0.8

8

0.7

0.4

4

C200

18.1

15.6

78

7.4

6.8

34

C600

12.4

12.6

21

7.5

8.4

14

C800

5.3

5.6

7

8.7

10.4

13

C1000

35.6

43.0

43

32.5

40.0

40

Unit upgrades

0.1

0.2

1







Total from Microturbine Products

$

102.7

103.2

628

$

89.9

96.1

627

Accessories, Parts and Service

24.9





19.5





Total

$

127.6

103.2

628

$

109.4

96.1

627

Sales
to Horizon Power Systems ("Horizon") accounted for 27% and 19% of our revenue for the years ended March 31, 2013 and 2012, respectively. Sales to BPC Engineering ("BPC")
accounted for 11% and 26% of our revenue for the years ended March 31, 2013 and 2012, respectively.

Gross Margin Cost of goods sold includes direct material costs, production and service center labor and overhead, inventory
charges and provision for
estimated product warranty expenses. The gross margin was $14.4 million, or 11% of revenue, for Fiscal 2013 compared to a gross margin of $5.4 million, or 5% of revenue, for Fiscal 2012.
The increase in gross margin was primarily related to an $10.6 million improvement resulting from higher volume of C200 and C1000 Series product shipments, microturbine parts and service
revenue, and lower direct material costs during Fiscal 2013. The $10.6 million improvement and the lower production and service center labor and expenses of $0.4 million were offset by
an increase in royalty expense of $1.1 million and warranty expense of $0.9 million. Management continues to implement initiatives to address warranty expense and to further reduce
direct material costs as we work to achieve profitability.

Production
and service center labor and overhead expense decreased $0.4 million during Fiscal 2013 compared to Fiscal 2012 primarily as the result of a decrease in freight
expense.

Royalty
expense increased $1.1 million during Fiscal 2013 compared to Fiscal 2012 as a result of higher sales of our C200 and C1000 Series systems. We pay a royalty of a
predetermined fixed rate for each microturbine system covered by our Development and License Agreement with Carrier which will be reduced by 50% once the aggregate of Carrier's cash and
in-kind services investment has been recovered. Management expects to reach this milestone during the second quarter of Fiscal 2014, at which time the predetermined fixed rate royalty
reduction will occur.

Warranty
expense is a combination of a standard warranty provision recorded at the time revenue is recognized and changes, if any, in estimates for reliability repair programs.
Reliability repair programs are based upon estimates that are recorded in the period that new information becomes available, including design changes, cost of repair and product enhancements, which
can include both in-warranty and out-of-warranty systems. The increase in warranty expense of $0.9 million reflects an increase in the standard warranty
provision as a result of an increase in warranty claims related primarily to certain C200 and C1000 Series systems, an increase in reliability repair programs and higher volume of C200 and C1000
Series units under warranty during Fiscal 2013 compared to the prior year. Management expects warranty claims levels for C200 and C1000 Series systems to decline as reliability repair programs are
completed and these products mature.

Research and Development Expenses R&D expenses include compensation, engineering department expenses, overhead allocations
for administration and
facilities and materials costs associated with development. R&D expenses for Fiscal 2013 increased $0.8 million, or 10%, to $9.0 million from $8.2 million for Fiscal 2012. R&D
expenses are reported net of benefits from cost-sharing programs, such as DOE grants. The overall increase in R&D expenses of $0.8 million resulted from increased supplies expense
of $0.8 million, salaries expense of $0.7 million and consulting expense of $0.2 million, offset by increased cost-sharing benefits of $0.9 million. There were
approximately $1.7 million of cost-sharing benefits for Fiscal 2013 and $0.8 million of such benefits for Fiscal 2012. Cost-sharing programs vary from period to
period depending on the phase of the programs. Management expects R&D expenses in Fiscal 2014 to be slightly higher than in Fiscal 2013 as we continue new product development, product robustness and
direct material cost reduction initiatives.

Selling, General and Administrative ("SG&A") Expenses SG&A expenses for Fiscal 2013 decreased $1.5 million, or 5%,
to $27.4 million
from $28.9 million for Fiscal 2012. The net decrease in SG&A expenses was comprised of a decrease of $2.0 million in bad debt expense and $0.9 million in professional
services expense, which includes accounting and legal expenses and facilities expense of $0.7 million, offset by an increase of salaries and related expenses of $1.4 million, business
travel expense of $0.4 million and marketing expense of $0.3 million. Management expects SG&A expenses in Fiscal 2014 to be slightly higher than in Fiscal 2013 as we focus on continuous
improvement in customer service levels and investment in software and hardware technology to support the growing business.

Interest Income There was no interest income during Fiscal 2013. Interest income was $2,000 for Fiscal 2012. Management expects
interest income in
Fiscal 2014 to be minimal because of current interest rates.

Interest Expense Interest expense decreased $0.2 million, or 22%, to $0.7 million during Fiscal 2013 from
$0.9 million during
Fiscal 2012. Interest expense is primarily from the average balances outstanding under the Credit Facility. As of March 31, 2013, we had total debt of $13.5 million outstanding under the
Credit Facility.

Change in Fair Value of Warrant Liability The change in fair value of the warrant liability was a benefit of $0.8 million
for Fiscal 2013. The
change in fair value of the warrant liability was a benefit of

$14.0 million
for Fiscal 2012. In accordance with ASC 815, "Derivatives and Hedging" adopted in Fiscal 2010, warrants previously classified within equity were reclassified as liabilities. This
change in fair value of warrant liability was a result of warrant exercises and revaluing the warrant liability based on the Monte Carlo simulation valuation model which is based primarily upon the
quoted price of the Company's common stock in an active market. This revaluation of the warrant liability has no impact on our cash balances.

Income Tax Provision Income tax expenses increased $0.5 million, or 250%, to $0.7 million during Fiscal 2013 from
$0.2 million
during Fiscal 2012. Income taxes incurred was primarily related to foreign taxes of $0.7 million. The effective income tax rate of 3.1% differs from the federal and state blended statutory rate
of 40% primarily as a result of recording taxable losses. At March 31, 2013, we had federal and state net operating loss carryforwards of approximately $592.0 million and
$283.9 million, respectively, which may be utilized to reduce future taxable income, subject to limitations under Section 382 of the Internal Revenue Code of 1986. We provided a
valuation allowance for 100% of our net deferred tax asset of $232.6 million at March 31, 2013 because the realization of the benefits of these favorable tax attributes in future income
tax returns is not deemed more likely than not. Similarly, at March 31, 2012, the net deferred tax asset was fully reserved.

Year Ended March 31, 2012 Compared to Year Ended March 31, 2011

Revenue Revenue for Fiscal 2012 increased $27.5 million, or 34%, to $109.4 million from $81.9 million for Fiscal
2011. The
change in revenue for Fiscal 2012 compared to Fiscal 2011 included increases in revenue of $17.9 million from the North American market, $11.1 million from the European market,
$0.8 million from the South American market and $0.8 million from the African market. The increase in the North American and European markets was primarily related to sales into the
shale gas market. The increase in the South American and African markets was primarily because of our continued efforts to improve distribution channels. This overall increase in revenue was offset by
decreases in revenue of $2.1 million from the Asian market and $1.0 million from the Australia market as a result of non-recurring microturbine product sales for specific
projects that had occurred in the same period last year.

For
Fiscal 2012, revenue from microturbine products increased $23.6 million, or 36%, to $89.9 million from $66.3 million for Fiscal 2011. Overall microturbine
product shipments were 16 units higher (26.4 megawatts higher) during Fiscal 2012 compared to Fiscal 2011, totaling 627 units (96.1 megawatts) and 611 units (69.7 megawatts), respectively. Average
revenue per unit increased for Fiscal 2012 to approximately $143,400 compared to approximately $109,000 per unit for Fiscal 2011. Megawatts shipped and revenue per unit during Fiscal 2012 increased as
a result of higher sales volume for our C65, C200 and C1000 Series microturbines, offset by lower sales volume for our TA100 microturbine as a result of the integration of the TA100 microturbine
manufacturing process into Capstone's facility in Van Nuys.

For
Fiscal 2012, revenue from our accessories, parts and service increased $3.9 million, or 25%, to $19.5 million from $15.6 million for Fiscal 2011. The increase in
revenue resulted from higher sales of microturbine parts, FPP contract enrollments and microturbine service work.

The
timing of shipments is subject to change based on several variables (including customer deposits, payments, availability of credit and delivery schedule changes), most of which are
not in our control and can affect the timing of our revenue and shipment of our products from backlog. Therefore, we evaluate historical revenue in conjunction with backlog to anticipate the growth
trend of our revenue.

The following table summarizes our revenue (revenue amounts in millions):

Years Ended March 31,

2012

2011

Revenue

Megawatts

Units

Revenue

Megawatts

Units

C30

$

4.4

3.2

108

$

6.0

4.4

148

C65

28.7

26.9

414

23.4

23.2

356

TA100

0.7

0.4

4

5.1

4.1

41

C200

7.4

6.8

34

5.3

5.0

25

C600

7.5

8.4

14

2.2

2.4

4

C800

8.7

10.4

13

4.4

5.6

7

C1000

32.5

40

40

18.6

24.0

24

Waste heat recovery generator







0.6

0.4

3

Unit upgrades







0.7

0.6

3

Total from Microturbine Products

$

89.9

96.1

627

$

66.3

69.7

611

Accessories, Parts and Service

19.5





15.6





Total

$

109.4

96.1

627

$

81.9

69.7

611

Sales
to BPC accounted for 26% and 23% of our revenue for the years ended March 31, 2012 and 2011, respectively. Sales to Pumps and Service accounted for 19% and 18% of our
revenue for the years ended March 31, 2012 and 2011, respectively.

Gross Margin (Loss) The gross margin was $5.4 million, or 5% of revenue, for Fiscal 2012 compared to a gross loss of
$0.5 million, or
1% of revenue, for Fiscal 2011. The increase in gross margin of $5.9 million was the result of a $13.0 million improvement realized from higher overall volume, increased average selling
prices and lower direct material cost during Fiscal 2012. All microturbine products had better margins than Fiscal 2011 as a result of higher average selling prices and overall lower direct material
costs. The $13.0 million improvement was offset by an increase in production and service center labor and overhead expenses of $3.3 million, warranty expense of $2.1 million,
royalty expense of $1.3 million and inventory charges of $0.4 million.

Production
and service center labor and overhead expense increased $3.3 million during Fiscal 2012 compared to Fiscal 2011 as the result of increased salaries, freight and
supplies expense and further development of our service centers to meet obligations under FPP contracts.

Warranty
expense is a combination of a standard warranty provision recorded at the time revenue is recognized and changes, if any, in estimates for reliability repair programs.
Reliability repair programs are estimates that are recorded in the period that new information becomes available, including design changes, cost of repair and product enhancements, which can include
both in-warranty and out-of-warranty systems. The increase in warranty expense of $2.1 million reflects an increase in the standard warranty provision as a
result of an increase in warranty claims related primarily to C200 and C1000 Series systems and higher volume of units under warranty during Fiscal 2012 compared to the prior year.

Royalty
expense increased $1.3 million during Fiscal 2012 compared to Fiscal 2011 as a result of higher sales of our C200 and C1000 Series systems. We pay an ongoing royalty of a
predetermined fixed rate for each microturbine system covered by our Development and License Agreement with Carrier Corporation.

Inventory
charges increased $0.4 million during Fiscal 2012 compared to Fiscal 2011 primarily as the result of physical inventory adjustments and reserve for excess and obsolete
inventory.

Research and Development Expenses R&D expenses for Fiscal 2012 increased $1.2 million, or 17%, to $8.2 million
from $7.0 million
for Fiscal 2011. R&D expenses are reported net of benefits from cost-sharing programs, such as DOE grants. The overall increase in R&D expenses of $1.2 million resulted from
increased salaries of $1.5 million, supplies of $0.2 million and reduced cost-sharing benefits of $0.1 million, offset by a decrease in consulting related expense of
$0.6 million. There were approximately $0.8 million of cost-sharing benefits for Fiscal 2012 and $0.9 million of such benefits for Fiscal 2011.
Cost-sharing programs vary from period to period depending on the phases of the programs.

Selling, General and Administrative ("SG&A") Expenses SG&A expenses for Fiscal 2012 increased $2.7 million, or 10%,
to $28.9 million
from $26.2 million for Fiscal 2011. The net increase in SG&A expenses was comprised of an increase of $2.0 million in bad debt expense, $0.6 million in professional services
expense, which includes accounting and legal expenses, $0.8 million in marketing expense and $0.4 million in consulting expense, offset by a decrease of $0.6 million in salary
expense and $0.5 million in travel expense.

Other Income Other income decreased $1,000, or 3%, to $31,000 for Fiscal 2012 from $32,000 for Fiscal 2011. Other income during
Fiscal 2012 was
primarily the result of a net gain on foreign exchange for statutory required foreign currency denominated bank accounts. Other income during Fiscal 2011was primarily related to the closure of our
office in Italy.

Interest Income Interest income decreased $2,000, or 50%, to $2,000 for Fiscal 2012 from $4,000 for Fiscal 2011. The decrease
during the period was
attributable to lower average cash balances.

Interest Expense Interest expense during each of Fiscal 2012 and Fiscal 2011 was approximately $0.9 million. Interest
expense incurred was
primarily determined by the average balances outstanding under the Credit Facility, as defined herein. As of March 31, 2012, we had total debt of $10.4 million outstanding under the
Credit Facility. Effective September 27, 2011, we increased our revolving line of credit to $15.0 million and extended the maturity date through September 30, 2014.

Change in Fair Value of Warrant Liability The change in fair value of the warrant liability was a benefit of $14.0 million
for Fiscal 2012.
The change in fair value of the warrant liability was a charge of $3.7 million for Fiscal 2011. In accordance with ASC 815, "Derivatives and Hedging" adopted in Fiscal 2010, warrants previously
classified within equity were reclassified as liabilities. This change in fair value of warrant liability was a result of warrant exercises and revaluing the warrant liability based on the Monte Carlo
simulation valuation model which is impacted primarily by the quoted price of the Company's common stock in an active market. This revaluation of the warrant liability has no impact on our cash
balances.

Income Tax Provision Income tax expenses during each of Fiscal 2012 and Fiscal 2011 were approximately $0.2 million. Income
taxes incurred was
primarily related to foreign taxes of $0.2 million. The effective income tax rate of 1.0% differs from the federal and state blended statutory rate of 40% primarily as a result of recording
taxable losses. At March 31, 2012, we had federal and state net operating loss carryforwards of approximately $572.5 million and $236.2 million, respectively, which may be
utilized to reduce future taxable income, subject to limitations under Section 382 of the Internal Revenue Code of 1986. We provided a valuation allowance for 100% of our net deferred tax asset
of $234.4 million at March 31, 2012 because the realization of the benefits of these favorable tax attributes in future income tax returns is not deemed more likely than not. Similarly,
at March 31, 2011, the net deferred tax asset was fully reserved.

The following table presents unaudited quarterly financial information. This information was prepared in accordance with GAAP, and, in
the opinion of management, contains all adjustments necessary for a fair presentation of such quarterly information when read in conjunction with the financial statements included elsewhere herein.
Our operating results for any prior quarters may not necessarily indicate the results for any future periods.

(In
thousands, except per share data)

Year Ended March 31, 2013

Year Ended March 31, 2012

(Unaudited)

Fourth
Quarter

Third
Quarter

Second
Quarter

First
Quarter

Fourth
Quarter

Third
Quarter

Second
Quarter

First
Quarter

Revenue

$

35,370

$

33,257

$

30,118

$

28,812

$

30,133

$

27,483

$

27,473

$

24,282

Cost of goods sold

30,378

28,639

27,512

26,643

29,222

25,143

25,804

23,775

Gross margin

4,992

4,618

2,606

2,169

911

2,340

1,669

507

Operating expenses:

R&D

2,174

2,188

2,413

2,204

2,007

1,823

2,245

2,162

SG&A

6,672

6,816

6,428

7,448

7,392

8,311

6,584

6,640

Loss from operations

(3,854

)

(4,386

)

(6,235

)

(7,483

)

(8,488

)

(7,794

)

(7,160

)

(8,295

)

Net income (loss)

$

(4,130

)

$

(4,477

)

$

(6,181

)

$

(7,775

)

$

(8,314

)

$

(8,818

)

$

1,264

$

(2,896

)

Net income (loss) per common sharebasic and diluted

$

(0.01

)

$

(0.01

)

$

(0.02

)

$

(0.03

)

$

(0.03

)

$

(0.03

)

$

0.00

$

(0.01

)

Liquidity and Capital Resources

Our cash requirements depend on many factors, including the execution of our plan. We expect to continue to devote substantial capital
resources to running our business and creating the strategic changes summarized herein. Our planned capital expenditures for the year ending March 31, 2014 include approximately
$2.0 million for plant and equipment costs related to manufacturing and operations. We have invested our cash in institutional funds that invest in high quality short-term money
market instruments to provide liquidity for operations and for capital preservation.

Our
cash and cash equivalent balances decreased $11.1 million during the year ended March 31, 2013, compared to an increase of $16.5 million during the year ended
March 31, 2012.

Operating Activities During the year ended March 31, 2013, we used $17.1 million of cash in our operating activities,
which consisted
of a net loss for the period of $22.6 million and cash used for working capital of $5.0 million, offset by non-cash adjustments (primarily change in fair value of warrant
liability, employee stock-based compensation, depreciation and amortization, warranty and inventory charges) of $10.5 million. During the year ended March 31, 2012, operating cash usage
was $21.4 million, which consisted of a net loss for the period of $18.8 million, cash used for working capital of $1.9 million and non-cash adjustments of
$0.7 million.

During
the year ended March 31, 2013, an additional $3.1 million in cash was used for working capital compared to the year ended March 31, 2012. The increase in cash
used for working capital during the year ended March 31, 2013 reflects the following:



An increase in inventory of $2.9 million during the year ended March 31, 2013 compared to an increase in
inventory of $1.0 million during the year ended March 31, 2012. The change in inventory increased $1.9 million during the year ended March 31, 2013 compared to the year
ended March 31, 2012 primarily as the result of the timing of certain deliveries from suppliers.

An increase in deferred revenue of $0.1 million during the year ended March 31, 2013 compared to an increase
in deferred revenue of $1.8 million during the year ended March 31, 2012. The change in deferred revenue decreased $1.7 million during the year ended March 31, 2013
compared to the year ended March 31, 2012 primarily as the result of a decrease in product down payments compared to the same period last year.



An increase in warranty payments of $4.3 million during the year ended March 31, 2013 compared to an
increase in warranty payments of $3.8 million during the year ended March 31, 2012. The change in warranty payments increased $0.5 million during the year ended March 31,
2013 compared to the year ended March 31, 2012 as a result of an increase in warranty claims related primarily to certain C200 and C1000 Series systems and higher volume of units under
warranty.



An increase in accounts payable and accrued expenses of $1.2 million during the year ended March 31, 2013
compared to an increase in accounts payable and accrued expenses of $2.7 million during the year ended March 31, 2012. The change in accounts payable and accrued expenses decreased
$1.5 million during the year ended March 31, 2013 compared to March 31, 2012 primarily as a result of inventory purchases and timing of payments, including unpaid royalty expense.



A decrease in accounts receivable of $0.3 million during the year ended March 31, 2013 compared to an
increase in accounts receivable of $1.5 million during the year ended March 31, 2012. The change in accounts receivable decreased $1.8 million during the year ended
March 31, 2013 compared to the year ended March 31, 2012 because of the timing of collections and prepayments.



A decrease in prepaid expenses and other current assets of $0.6 million during the year ended March 31, 2013
compared to an increase in prepaid expenses and other current assets of $0.2 million during the year ended March 31, 2012. The change in prepaid expenses and other current assets of
$0.8 million during the year ended March 31, 2013 compared to the year ended March 31, 2012 resulted from deposits and prepayments on inventory.

Investing Activities Net cash used in investing activities of $1.2 million during the year ended March 31, 2013 relates
primarily to
the acquisition of fixed assets. Net cash used in investing activities of $0.2 million during the year ended March 31, 2012 relates primarily to $1.5 million used for the
acquisition of fixed assets during the year ended March 31, 2012 offset by a benefit from the release of the remaining $1.3 million of restricted cash from Wells Fargo, which was
previously restricted as additional security for the Credit Facility.

Financing Activities During the year ended March 31, 2013, we generated $7.1 million from financing activities compared
to cash
generated during the year ended March 31, 2012 of $38.1 million. The funds generated from financing activities during the year ended March 31, 2013 were primarily from the
proceeds related to exercise of the Put Option described below and additional borrowings under the Credit Facility. During the year ended March 31, 2012, the funds generated from financing
activities were primarily from proceeds related to our registered direct placement of securities described below, the exercise of common stock warrants and additional borrowings under the Credit
Facility. Net borrowings under the Credit Facility was $3.0 million during the year ended March 31, 2013 compared to net borrowings of $3.4 million during the year ended
March 31, 2012.

Effective
March 5, 2012, the Company completed a registered direct placement in which it sold 22.6 million shares of the Company's common stock, par value $.001 per share,
and warrants to purchase 22.6 million shares of common stock with an initial exercise price of $1.55 per share, at a price of $1.11 per unit. Each unit consisted of one share of common stock
and a warrant to purchase one share of common stock. The warrants expire on October 31, 2013. In addition, the Company

obtained
the right to require investors in the offering to purchase up to an aggregate maximum of 19.0 million additional shares of common stock from the Company (the "Put Options") during two
option exercise periods, the first such option exercise period beginning September 10, 2012 and the second such option exercise period beginning March 4, 2013. Each Put Option was
subject to certain conditions which could reduce the number of shares that could be sold or eliminate the Put Option. These conditions included a minimum volume-weighted average price (VWAP) and a
minimum average trading volume of the Company's common shares during the 30 trading days prior to the exercise of the Put Option. The March 2012 sale resulted in gross proceeds of approximately
$25.0 million and proceeds net of direct incremental costs of approximately $23.1 million.

On
September 18, 2012, the Company entered into an Investor Agreement with one of the investors in the 2012 registered direct offering pursuant to which the investor agreed to
(i) waive the condition precedent to the Company's exercise of the Put Option requiring the arithmetic average of the average daily trading volumes during the measurement period set forth in
the subscription agreement between the Company and the investor and on the exercise date be not less than 1.75 million shares and (ii) amend the subscription agreement to provide that
the purchase price of the additional shares during the first exercise period would be discounted pursuant to a formula that resulted in a purchase price for the first exercise period of $0.94 per
share. Additionally, pursuant to the Investor Agreement, the Company agreed to amend the exercise price of the warrant originally issued to $1.26. The exercise of the Put Option resulted in net
proceeds of $4.2 million. On February 21, 2013, the Company chose not to exercise the second of the two Put Options because of its improved cash position and its desire to avoid
stockholder dilution.

Repurchases
of shares of our common stock for employee taxes due on vesting of restricted stock units net of employee stock purchases resulted in approximately $19,000 of net cash used
during Fiscal 2013, compared with $0.7 million of net cash generated during Fiscal 2012.

We
maintain two Credit and Security Agreements, as amended (the "Agreements"), with Wells Fargo, which provide the Company with a line of credit of up to $15.0 million in the
aggregate (the "Credit Facility"). The amount actually available to us may be less and may vary from time to time depending on, among other factors, the amount of eligible inventory and accounts
receivable. As security for the payment and performance of the Credit Facility, we granted a security interest in favor of Wells Fargo in substantially all of our assets. The Agreements will terminate
in accordance with their terms on September 30, 2014. As of March 31, 2013 and March 31, 2012, $13.5 million and $10.4 million in borrowings were outstanding,
respectively, under the Credit Facility.

The
Agreements include affirmative covenants as well as negative covenants that prohibit a variety of actions without Wells Fargo's consent, including covenants that limit our ability to
(a) incur or guarantee debt, (b) create liens, (c) enter into any merger, recapitalization or similar transaction or purchase all or substantially all of the assets or stock of
another entity, (d) pay dividends on, or purchase, acquire, redeem or retire shares of, our capital stock, (e) sell, assign, transfer or otherwise dispose of all or
substantially all of our assets, (f) change our accounting method or (g) enter into a different line of business. Furthermore, the Agreements contain financial covenants, including
(a) a requirement not to exceed specified levels of losses, (b) a requirement to maintain a substantial minimum monthly cash balance to outstanding line of credit advances based upon the
Company's financial performance, and (c) limitations on our annual capital expenditures.

Several
times since entering into the Agreements and prior to April 1, 2012, we were not in compliance with certain covenants under the Credit Facility. In connection with each
event of noncompliance, Wells Fargo waived the event of default and, on several occasions, we amended the Agreements in response to the default and waiver. If we had not obtained the waivers and
amended the Agreements as described above, we would not be able to draw additional funds under the Credit Facility. In addition, the Company has pledged its accounts receivables, inventories,
equipment, patents

and
other assets as collateral for its Agreements, which would be subject to seizure by Wells Fargo if the Company were in default under the Agreements and unable to repay the indebtedness. Wells
Fargo also has the option to terminate the Agreements or accelerate the indebtedness during a period of noncompliance. Based on our current forecasts, management believes we will maintain compliance
with the covenants contained in the amended Agreements for at least the next twelve months. If a covenant violation were to occur, management would attempt to negotiate a waiver of compliance from
Wells Fargo. On June 7, 2013, we entered into an amendment to the Agreements which set the financial covenants for Fiscal 2014. As of March 31, 2013, we were in compliance with the
covenants contained in the amended Agreements for Fiscal 2013.

Although
we made progress on direct material cost reduction efforts during Fiscal 2013, we were behind schedule on our planned cost reductions at the end of Fiscal 2013. Our working
capital requirements were in accordance with our plan for Fiscal 2013. Management believes that existing cash and cash equivalents are sufficient to meet our anticipated cash needs for working capital
and capital expenditures for at least the next twelve months; however, if our anticipated cash needs change, it is possible that we may need to raise additional capital in the future. We could seek to
raise funds by selling additional securities to the public or to selected investors, or by obtaining additional debt financing. There is no assurance that we will be able to obtain additional funds on
commercially favorable terms, or at all. If the Company raises additional funds by issuing additional equity or convertible debt securities, the fully diluted ownership percentages of existing
stockholders will be reduced. In addition, the equity or debt securities that the Company would issue may have rights, preferences or privileges senior to those of the holders of its common stock.

Although
we believe we have sufficient capital to fund our working capital and capital expenditures for at least the next twelve months, depending on the timing of our future sales and
collection of related receivables, managing inventory costs and the timing of inventory purchases and deliveries required to fulfill the backlog, our future capital requirements may vary materially
from those now planned. The
amount of capital that we will need in the future will require us to achieve significantly increased sales volume which is dependent on many factors,
including:



the market acceptance of our products and services;



our business, product and capital expenditure plans;



capital improvements to new and existing facilities;



our competitors' response to our products and services;



our relationships with customers, distributors, dealers and project resellers; and



our customers' ability to afford and/or finance our products.

Our
accounts receivable balance, net of allowance for doubtful accounts, was $17.9 million and $18.5 million as of March 31, 2013 and March 31, 2012,
respectively. Accounts receivable days sales outstanding ("DSO") decreased by 10 days, to 46 days as of March 31, 2013 compared to 56 days as of March 31, 2012. The
change in DSO was largely the result of the shift in mix of sales away from European customers who historically have longer payment terms towards customers in the United States and Latin America who
have shorter payment terms or are required to pay before shipment. We recorded bad debt expense of $0.3 million, $2.3 million and $0.2 million for the years ended March 31,
2013, 2012 and 2011. No assurances can be given that future bad debt expense will not increase above current operating levels. Increased bad debt expense or delays in collecting accounts receivable
could have a material adverse effect on cash flows and results of operations. In addition, our ability to access the capital markets may be severely restricted or made very expensive at a time when we
need, or would like, to do so, which could have a material adverse impact on our liquidity and financial

resources.
Certain industries in which our customers do business and certain geographic areas have been and could continue to be adversely affected by the current economic environment.

Contractual Obligations and Commercial Commitments

At March 31, 2013, our commitments under notes payable, capital leases and non-cancelable operating leases were as
follows (in thousands):

Payment Due by Period

Total

1 Year
or Less

1 - 3
Years

3 - 5
Years

More
than
5 Years

Contractual Obligations:

Notes payable and capital lease obligations

$

594

$

361

$

206

$

27

$



Operating lease obligations

5,160

1,881

2,695

584



Revolving credit facility

13,476

13,476







Total

$

19,230

$

15,718

$

2,901

$

611

$



As
of March 31, 2013, we had firm commitments to purchase inventories of approximately $31.5 million through Fiscal 2014. Certain inventory delivery dates and related
payments are not firmly scheduled; therefore, amounts under these firm purchase commitments will be payable concurrent with the receipt of the related inventories.

Agreements
we have with some of our distributors require that if we render parts obsolete in inventories they own and hold in support of their obligations to serve fielded microturbines,
then we are required to replace the affected stock at no cost to the distributors. While we have never incurred costs or obligations for these types of replacements, it is possible that future changes
in product technology could result and yield costs if significant amounts of inventory are held at distributors. As of March 31, 2013, no significant inventories were held at distributors.

Pursuant
to the terms of our Agreements with Wells Fargo, the minimum interest payable under the Credit Facility is $66,000 each calendar quarter. The Agreements will terminate in
accordance with their terms on September 30, 2014.

On
February 1, 2010, the Company and CPS also entered into an agreement pursuant to which we agreed to purchase 125 kW waste heat recovery generator systems from CPS, which
agreement was subsequently assigned to General Electric Company ("GE") in October of 2010. In exchange for certain minimum purchase requirements of $18.7 million through December 2015, we have
exclusive rights to sell the zero-emission waste heat recovery generator for all microturbine applications and for applications 500 kW or lower where the source of heat is the exhaust of a
reciprocating engine used in a landfill application. As of March 31, 2013, we were not in compliance with the minimum purchase requirements in the agreement. Loss of exclusivity is dependent
upon receiving proper notification from GE as set forth in the agreement.

Off-Balance Sheet Arrangements

We do not have any material off-balance sheet arrangements.

Inflation

Inflation did not have a material impact on our results of operations or financial condition for the fiscal years ended
March 31, 2013, 2012 and 2011. In an effort to offset the adverse impact of inflation on earnings, we have historically raised selling prices on all products, parts, accessories and services.

However,
any future adverse impact of inflation on our raw materials and energy costs may not be similarly recoverable through our selling price increases.

Item 7A. Quantitative and Qualitative Disclosure About Market Risk.

Foreign Currency

We currently develop products in the U.S. and market and sell our products predominantly in North America, Europe and Asia. As a
result, factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets could affect our financial results. As all of our sales and purchases are currently
made in U.S. dollars, we do not utilize foreign exchange contracts to reduce our exposure to foreign currency fluctuations. In the future, as our customers, employees and vendor bases expand, we may
enter into transactions that are denominated in foreign currencies.

Interest

Our exposure to changes in the interest rates results primarily from our Credit Facility borrowings. As of March 31, 2013, we
had $13.5 million of outstanding indebtedness subject to interest rate fluctuations. Based on these borrowings as of March 31, 2013, a hypothetical 100 basis point increase in the then
current LIBOR rate would increase our interest expense by $0.1 million on an annual basis. The level of outstanding indebtedness fluctuates from period to period and therefore could result in
additional interest.

Item 8. Financial Statements and Supplementary Data.

Our Consolidated Financial Statements and Financial Statement Schedule included in this Annual Report beginning at
page F-1 are incorporated in this Item 8 by reference.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

Item 9A. Controls and Procedures.

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that the information required to be disclosed in the
Company's reports under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and
forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), as appropriate, to allow timely
decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control objectives.

In
connection with the preparation of this Annual Report on Form 10-K for the year ended March 31, 2013, an evaluation was performed under the supervision and
with the participation of our management, including the CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in
Rule 13a-15(e) under the Exchange Act). Based on this evaluation, our CEO and CFO have concluded that our disclosure controls and procedures are effective as of March 31,
2013 to ensure that the information required to be disclosed by us in reports we submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the
rules and forms of the SEC. Additionally, such information is accumulated and

Management's Annual Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is
defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we conducted an
evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring
Organization of the Treadway Commission. Based on our evaluation under the framework in Internal
ControlIntegrated Framework, our management concluded that the Company maintained effective internal control over financial reporting as of March 31, 2013. KPMG LLP, the
Company's independent registered public accounting firm, has issued a report on the Company's internal control over financial reporting. The report of KPMG LLP follows. Projections of any
evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company's internal control over financial reporting during the three month period ended March 31,
2013 which have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

We
have audited Capstone Turbine Corporation's (the "Company") internal control over financial reporting as of March 31, 2013, based on criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Capstone Turbine Corporation's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on
Internal Control Over Financial
Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

We
conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our
audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A
company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In
our opinion, Capstone Turbine Corporation maintained, in all material respects, effective internal control over financial reporting as of March 31, 2013, based on criteria
established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We
also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Capstone Turbine Corporation
and subsidiaries as of March 31, 2013, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended, and the related financial statement
schedule, and our report dated June 13, 2013 expressed an unqualified opinion on those consolidated financial statements and financial statement schedule.

Information contained under the caption "Proposal 1: Election of Directors to the Board of Directors" included in our proxy statement
relating to our 2013 annual meeting of stockholders is incorporated herein by reference.

Executive Officers

Information contained under the caption "Executive Officers of the Company" included in our proxy statement relating to our 2013 annual
meeting of stockholders is incorporated herein by reference.

Information contained under the caption "Other InformationCode of Business Conduct and Code of Ethics" included in our
proxy statement relating to our 2013 annual meeting of stockholders is incorporated herein by reference.

Stockholder Nominees

Information contained under the caption "Governance of the Company and Practices of the Board of DirectorsDirector
Recommendation and Nomination Process" included in our proxy statement relating to our 2013 annual meeting of stockholders is incorporated herein by reference.

Audit and Compliance Committee

Information contained under the caption "Governance of the Company and Practices of the Board of DirectorsBoard
CommitteesAudit Committee" included in our proxy statement relating to our 2013 annual meeting of stockholders is incorporated herein by reference.

Information contained under the caption "Securities Authorized for Issuance under Equity Compensation Plans" included in our proxy
statement relating to our 2013 annual meeting of stockholders is incorporated herein by reference.

Security Ownership of Certain Beneficial Owners and Management

Information contained under the caption "Security Ownership of Certain Beneficial Owners and Management" included in our proxy
statement relating to our 2013 annual meeting of stockholders is incorporated herein by reference.

Information contained under the captions "Other InformationRelated Person Transactions Policies and Procedures" and
"Governance of
the Company and Practices of the Board of DirectorsBoard of Directors; Leadership Structure" included in our proxy statement relating to our 2013 annual meeting of stockholders is
incorporated herein by reference.

Item 14. Principal Accounting Firm Fees and Services.

Information contained under the caption "Fees and Services of the Independent Registered Public Accounting Firm" included in our proxy
statement relating to our 2013 annual meeting of stockholders is incorporated herein by reference.

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32

Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS

**

XBRL Instance Document

101.SCH

**

XBRL Schema Document

101.CAL

**

XBRL Calculation Linkbase Document

101.LAB

**

XBRL Label Linkbase Document

101.PRE

**

XBRL Presentation Linkbase Document

101.DEF

**

XBRL Definition Linkbase Document

*

Management
contract or compensatory plan or arrangement

**

Pursuant
to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or
prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise not subject to liability under these
Sections.

(a)

Incorporated
by reference to Capstone Turbine Corporation's Current Report on Form 8-K, filed on February 29, 2012 (File
No. 001-15957).

(b)

Incorporated
by reference to Capstone Turbine Corporation's Current Report on Form 8-K, filed on February 5, 2010 (File
No. 001-15957).

(c)

Incorporated
by reference to Capstone Turbine Corporation's Annual Report on Form 10-K for the fiscal year ended March 31, 2011
(File No. 001-15957).

Financial
statement schedules not included in this Annual Report on Form 10-K have been omitted because they are not applicable or the required information is shown in
the financial statements or notes thereto.

We
have audited the accompanying consolidated balance sheet of Capstone Turbine Corporation and subsidiaries (the "Company") as of March 31, 2013, and the related consolidated
statements of operations, stockholders' equity, and cash flows for the year then ended. In connection with our audit of the consolidated financial statements, we also have audited financial statement
schedule II valuation and qualifying accounts for the year ended March 31, 2013. These consolidated financial statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is
to express an opinion on these consolidated financial statements and financial statement schedule based on our audit.

We
conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Capstone Turbine Corporation and subsidiaries
as of March 31, 2013, and the results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles. Also in our opinion,
the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set
forth therein for the year ended March 31, 2013.

We
also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Capstone Turbine Corporation's internal control over financial
reporting as of March 31, 2013, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO), and our report dated June 13, 2013 expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.

To
the Board of Directors and Stockholders of
Capstone Turbine Corporation
Chatsworth, California

We
have audited the accompanying consolidated balance sheet of Capstone Turbine Corporation and subsidiaries (the "Company") as of March 31, 2012 and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended March 31, 2012. Our audits also included the financial statement schedule listed in
the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Capstone Turbine Corporation and subsidiaries at
March 31, 2012, and the results of their operations and their cash flows for each of the two years in the period ended March 31, 2012, in conformity with accounting principles generally
accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present
fairly, in all material respects, the information set forth therein.

During the year ended March 31, 2011, the Company issued 3,131,313 shares of common stock to Calnetix Power Solutions, Inc. in connection with
the acquisition of the Calnetix microturbine generator product line. See Note 15Acquisition, for a discussion of the tangible and intangible assets acquired and the details of the acquisition.

In connection with the January 9, 2012 exercise of warrants, the Company recorded $1.6 million to additional paid-in capital to settle the
warrant liability.

In connection with the March 9, 2011 exercise of warrants, the Company recorded $11.2 million to additional paid-in capital to settle the
warrant liability.

During the years ended March 31, 2013, 2012 and 2011, the Company incurred $476 thousand, $635 thousand and $443 thousand,
respectively, in connection with the renewal of insurance contracts, which was financed by notes payable.

Included in accounts payable at March 31, 2013, 2012 and 2011 is $26 thousand, $187 thousand, and $78 thousand of accrued purchases
of property and equipment, respectively.

During the year ended March 31, 2013, the Company purchased fixed assets in consideration for the issuance of a note payable of $306 thousand.
There were no fixed assets purchased with a note payable during the years ended March 31, 2012 and 2011.

Capstone Turbine Corporation (the "Company") develops, manufactures, markets and services microturbine technology solutions for use in stationary distributed power generation
applications, including cogeneration (combined heat and power ("CHP"), integrated combined heat and power ("ICHP"), and combined cooling, heat and power ("CCHP")), renewable energy, natural resources
and critical power supply. In addition, the Company's microturbines can be used as battery charging generators for hybrid electric vehicle applications. The Company was organized in 1988 and has been
commercially producing its microturbine generators since 1998.

The
Company has incurred significant operating losses since its inception. Management anticipates incurring additional losses until the Company can produce sufficient revenue to cover
its operating costs. To date, the Company has funded its activities primarily through private and public equity offerings. This Annual Report on Form 10-K (this
"Form 10-K") refers to the Company's fiscal years ending March 31 as its "Fiscal" years.

The
consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. The Company's net loss from operations for the Fiscal years ended 2013, 2012 and 2011 was $22.0 million, $31.7 million and
$33.7 million, respectively. Management believes the improvement in the net loss will continue as the Company makes overall progress on our path to profitability. The Company's cash and cash
equivalents as of March 31, 2013 and 2012 were $38.8 million and $50.0 million, respectively. The Company's change in cash and cash equivalents and its working capital
requirements were in accordance with management's plan during Fiscal 2013.

Management
believes that existing cash and cash equivalents are sufficient to meet the Company's anticipated cash needs for working capital and capital expenditures for at least the next
twelve months; however, if our anticipated cash needs change, it is possible that the Company may need to raise additional capital in the future. The Company may seek to raise funds by selling
additional securities to the public or to selected investors or by obtaining additional debt financing. There is no assurance that the Company will be able to obtain additional funds on commercially
favorable terms, or at all. If the Company raises additional funds by issuing additional equity or convertible debt securities, the fully diluted ownership percentages of existing stockholders will be
reduced. In addition, any equity or debt securities that the Company would issue may have rights, preferences or privileges senior to those of the holders of its common stock.

The
consolidated financial statements include the accounts of the Company, Capstone Turbine International, Inc., its wholly owned subsidiary that was formed in June 2004, and
Capstone Turbine Singapore Pte., Ltd., its wholly owned subsidiary that was formed in February 2011, after elimination of inter-company transactions.

2. Summary of Significant Accounting Policies

Cash Equivalents The Company considers only those investments that are highly liquid and readily convertible to cash with
original maturities of
three months or less at date of purchase as cash equivalents.

Restricted Cash As of March 31, 2011, the Company had maintained $1.3 million as additional security for
its line of credit with Wells Fargo. During Fiscal 2012, Wells Fargo released $1.3 million of the restricted cash.

Accounts Receivable The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of
customers to make
required payments.

Inventories The Company values inventories at first in first out ("FIFO") basis and lower of cost or market. The composition of
inventory is
routinely evaluated to identify slow-moving, excess, obsolete or otherwise impaired inventories. Inventories identified as impaired are evaluated to determine if write-downs are required.
Included in the assessment is a review for obsolescence as a result of engineering changes in the Company's products. All inventories expected to be used in more than one year are classified as
long-term.

Depreciation and Amortization Depreciation and amortization are provided for using the straight-line method over the estimated
useful
lives of the related assets, ranging from two to ten years. Leasehold improvements are amortized over the lease term or the estimated useful lives of the assets, whichever is shorter. Intangible
assets that have finite useful lives are amortized over their estimated useful lives using the straight-line method with the exception of the backlog of 100 kW microturbines ("TA100")
acquired from Calnetix Power Solutions, Inc. ("CPS").
Purchased backlog is amortized based on unit sales and presented as a component of cost of goods sold.

Long-Lived Assets The Company reviews the recoverability of long-lived assets, including intangible assets with finite lives,
whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. If the expected future cash flows from the use of such assets (undiscounted and
without interest charges) are less than the carrying value, the Company may be required to record a write-down, which is determined based on the difference between the carrying value of
the assets and their estimated fair value. The Company performed an analysis as of March 31, 2013 and determined that no impairment was necessary. Intangible assets include a manufacturing
license, trade name, technology, backlog and customer relationships. See Note 5Intangible Assets.

Deferred Revenue Deferred revenue consists of deferred product and service revenue and customer deposits. Deferred revenue will
be recognized when
earned in accordance with the Company's revenue recognition policy. The Company has the right to retain all or part of customer deposits under certain conditions.

Revenue The Company's revenue consists of sales of products, parts, accessories and service, which includes a comprehensive
Factory Protection Plan
("FPP"), net of discounts. Capstone's distributors purchase products, parts and FPPs for sale to end users and are also required to provide a variety of additional services, including application
engineering, installation, commissioning and post-commissioning repair and maintenance service. The Company's standard terms of sales to distributors and direct end-users
include transfer of title, care, custody and control at the point of shipment, payment terms ranging from full payment in advance of shipment to payment in 90 days, no

right
of return or exchange, and no post-shipment performance obligations by Capstone except for warranties provided on the products and parts sold.

Revenue
from the sale of products, parts and accessories is generally recognized and earned when all of the following criteria are satisfied: (a) persuasive evidence of a sales
arrangement exists; (b) price is
fixed or determinable; (c) collectability is reasonably assured; and (d) delivery has occurred. Delivery generally occurs when the title and the risks and rewards of ownership have
substantially transferred to the customer. Service performed by the Company has consisted primarily of time and materials based contracts. The time and materials contracts are usually related to
out-of-warranty units. Service revenue derived from time and materials contracts is recognized as the service is performed. The Company also provides maintenance service
contracts to customers of its existing installed base. The maintenance service contracts are agreements to perform certain services to maintain a product for a specified period of time. Service
revenue derived from maintenance service contracts is recognized on a straight-line basis over the contract period.

The
Company occasionally enters into agreements that contain multiple elements, such as sale of equipment, installation, engineering and/or service. The Company allocates the total
contract value among each element based on a selling price hierarchy as follows, where the selling price is based on (i) vendor specific objective evidence ("VSOE"), (ii) third party
evidence ("TPE") or (iii) best estimate of selling price if VSOE or TPE are not available. Revenue is the amount related to each element or recognized in accordance with the revenue recognition
policies discussed above.

Warranty The Company provides for the estimated costs of warranties at the time revenue is recognized. The specific terms and
conditions of those
warranties vary depending upon the product sold and geography of sale. The Company's product warranties generally start from the delivery date and continue for up to eighteen months. Factors that
affect the Company's warranty obligation include product failure rates, anticipated hours of product operations and costs of repair or replacement in correcting product failures. These factors are
estimates that may change based on new information that becomes available each period. Similarly, the Company also accrues the estimated costs to address reliability repairs on products no longer in
warranty when, in the Company's judgment, and in accordance with a specific plan developed by the Company, it is prudent to provide such repairs. The Company assesses the adequacy of recorded warranty
liabilities quarterly and makes adjustments to the liability as necessary. When the Company has sufficient evidence that product changes are altering the historical failure occurrence rates, the
impact of such changes is then taken into account in estimating future warranty liabilities.

Research and Development ("R&D") The Company accounts for grant distributions and development funding as offsets to R&D
expenses and both are
recorded as the related costs are incurred. Total offsets to R&D expenses amounted to $1.7 million, $0.8 million and $0.9 million for the years ended March 31, 2013, 2012
and 2011, respectively.

Income Taxes Deferred income tax assets and liabilities are computed for differences between the consolidated financial
statement and income tax
basis of assets and liabilities. Such deferred income tax asset and liability computations are based on enacted tax laws and rates applicable to periods in which
the differences are expected to reverse. Valuation allowances are established, when necessary, to reduce deferred income tax assets to the amounts expected to be realized.

Contingencies The Company records an estimated loss from a loss contingency when information available prior to issuance of its
financial statements
indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of the loss can be reasonably estimated.

Risk Concentrations Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily
of cash and cash
equivalents and accounts receivable. At March 31, 2013, the majority of our cash balances were held at financial institutions located in California, in accounts that are insured by the Federal
Deposit Insurance Corporation. Uninsured balances aggregate to approximately $38.6 million as of March 31, 2013. The Company places its cash and cash equivalents with high credit quality
institutions. The Company performs ongoing credit evaluations of its customers and maintains an allowance for potential credit losses.

Sales
to Horizon Power Systems ("Horizon"), one of the Company's domestic distributors, accounted for 27%, 19% and 18% of revenue for the years ended March 31, 2013, 2012 and
2011, respectively. Sales to BPC Engineering ("BPC"), one of the Company's Russian distributors, accounted for 11%, 26% and 23% of revenue for the years ended March 31, 2013, 2012 and 2011,
respectively. Additionally, BPC and Regatta Solutions, Inc., one of the Company's domestic distributors, accounted for 35% and 11%, respectively, of net accounts receivable as of
March 31, 2013. BPC accounted for 44% of net accounts receivable as of March 31, 2012.

Accounts
receivable, net as of March 31, 2013 and 2012 includes $0.3 million and $0.1 million of other receivables, respectively from the U.S. Department of Energy
("DOE") under grants awarded in 2009 and 2010.

The
Company recorded bad debt expense of $0.3 million, $2.3 million and $0.2 million for the years ended March 31, 2013, 2012 and 2011, respectively.

Certain
components of the Company's products are available from a limited number of suppliers. An interruption in supply could cause a delay in manufacturing, which would affect
operating results adversely.

Estimates and Assumptions The preparation of financial statements in conformity with accounting principles generally accepted in
the United States of
America requires management to make certain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant estimates include accounting for
doubtful accounts, stock-based compensation, inventory write-downs, valuation of long-lived assets including intangible assets with finite lives, product warranties, income taxes and other
contingencies. Actual results could differ from those estimates.

Net Loss Per Common Share Basic loss per common share is computed using the weighted-average number of common shares outstanding
for the period.
Diluted loss per share is also computed without consideration to potentially dilutive instruments because the Company incurred losses which would make such instruments antidilutive. Outstanding stock
options at March 31, 2013, 2012 and 2011 were 11.8 million, 10.0 million and 10.1 million, respectively. Outstanding restricted stock units at March 31, 2013, 2012
and 2011 were 1.5 million, 1.1 million and 1.5 million, respectively. As of March 31, 2013, 2012 and 2011, the number of warrants excluded from diluted net loss per common
share computations was approximately 26.5 million, 26.5 million and 21.7 million, respectively.

Stock-Based Compensation Options or stock awards are recorded at their estimated fair value at the measurement date. The Company
recognizes
compensation cost for options and stock awards that have a graded vesting schedule on a straight-line basis over the requisite service period for the entire award.

Segment Reporting The Company is considered to be a single reporting segment. The business activities of this reporting segment
are the development,
manufacture and sale of turbine generator sets and their related parts and service. Following is the geographic revenue information based on the primary operating location of the Company's customers
(in thousands):

Year Ended March 31,

2013

2012

2011

United States

$

57,001

$

41,796

$

25,630

Mexico

22,581

7,798

5,416

All other North America

4,370

116

808

Total North America

83,952

49,710

31,854

Russia

13,827

29,722

20,655

All other Europe

12,036

17,452

15,375

Total Europe

25,863

47,174

36,030

Asia

8,473

5,692

7,811

Australia

5,461

2,749

3,754

All other

3,808

4,046

2,441

Total Revenue

$

127,557

$

109,371

$

81,890

The
following table summarizes the Company's revenue by product (in thousands):

Year Ended March 31,

2013

2012

2011

C30

$

6,756

$

4,426

$

6,043

C65

22,899

28,680

23,377

TA100

1,485

681

5,121

C200

18,099

7,361

5,289

C600

12,384

7,567

2,172

C800

5,324

8,728

4,362

C1000

35,571

32,475

18,619

Waste heat recovery generator





627

Unit upgrades

129



704

Total from Microturbine Products

102,647

89,918

66,314

Accessories, Parts and Service

24,910

19,453

15,576

Total

$

127,557

$

109,371

$

81,890

Substantially
all of the Company's operating assets are in the United States.

Inventories are valued on a FIFO basis and lower of cost or market and consisted of the following as of March 31, 2013 and 2012 (in thousands):

2013

2012

Raw materials

$

20,198

$

18,476

Work in process



151

Finished goods

1,567

1,567

Total

21,765

20,194

Less non-current portion

(3,252

)

(1,313

)

Current portion

$

18,513

$

18,881

The
non-current portion of inventories represents that portion of the inventories in excess of amounts expected to be used in the next twelve months. The
non-current inventories are primarily comprised of repair parts for older generation products that are still in operation, but are not technologically compatible with current
configurations. The weighted average age of the non-current portion of inventories on hand as of March 31, 2013 is 1.6 years. The Company expects to use the
non-current portion of the inventories on hand as of March 31, 2013 over the periods presented in the following table (in thousands):

Expected Period of Use

Non-current
Inventory Balance
Expected to be Used

13 to 24 months

$

2,401

25 to 36 months

567

37 to 48 months

284

Total

$

3,252

4. Property, Plant and Equipment

Property, plant and equipment as of March 31, 2013 and 2012 consisted of the following (in thousands):

2013

2012

Estimated
Useful Life

Machinery, rental equipment, equipment, automobiles and furniture

$

20,649

$

20,506

2 - 10 years

Leasehold improvements

9,708

9,696

10 years

Molds and tooling

4,933

4,880

2 - 5 years

35,290

35,082

Less, accumulated depreciation

(31,747

)

(30,249

)

Total property, plant and equipment, net

$

3,543

$

4,833

Depreciation
expense for property, plant and equipment was $2.3 million, $2.6 million and $2.8 million for the years ended March 31, 2013, 2012 and 2011,
respectively.

The manufacturing license provides the Company with the ability to manufacture recuperator cores previously purchased from Solar Turbines Incorporated ("Solar"). The Company is required
to pay a per-unit royalty fee over a seventeen-year period for cores manufactured and sold by the Company using the technology. Royalties of approximately $76,700, $72,800, and
$62,800 were earned by Solar for the years ended March 31, 2013, 2012 and 2011, respectively. Earned
royalties of approximately $24,600 and $17,500 were unpaid as of March 31, 2013 and 2012, respectively, and are included in accrued expenses in the accompanying balance sheets.

6. Accrued Warranty Reserve

Changes in the accrued warranty reserve are as follows as of March 31, 2013, 2012 and 2011 (in thousands):

2013

2012

2011

Balance, beginning of the period

$

1,494

$

1,081

$

1,036

Standard warranty provision

3,874

3,790

2,015

Changes for accrual related to reliability repair programs

1,255

437

74

Deductions for warranty claims

(4,324

)

(3,814

)

(2,044

)

Balance, end of the period

$

2,299

$

1,494

$

1,081

7. Deferred Revenue

Changes in deferred revenue are as follows as of March 31, 2013 (in thousands):

Current income tax provision is the amount of income taxes reported or expected to be reported on our income tax return. The provision for current income taxes for the year ended
March 31, 2013 was $0.7 million, which was all related to foreign taxes. The Company did not have current federal income taxes for the year ended March 31, 2013.

Actual
income tax expense differed from the amount computed by applying statutory corporate income tax rates to loss from operations before income taxes. A reconciliation of income tax
(benefit) expense to the federal statutory rate follows (in thousands):

Year Ended March 31,

2013

2012

2011

Federal income tax at the statutory rate

$

(7,436

)

$

(6,317

)

$

(12,997

)

State taxes, net of federal effect

(661

)

(727

)

(1,390

)

Foreign taxes

675

313

461

R&D tax credit

(1,157

)

(455

)

(367

)

Impact of state rate change

838

(693

)

1,541

Warrant liability

(299

)

(5,301

)

9,981

Expiring NOL



9,765

6,278

Valuation allowance

(1,877

)

3,423

(4,343

)

Excess tax benefitstock compensation

10,383





Other

228

178

1,076

Income tax expense (benefit)

$

694

$

186

$

240

The
Company's deferred tax assets and liabilities consisted of the following at March 31, 2013 and 2012 (in thousands):

2013

2012

Deferred tax assets:

Inventories

$

1,754

$

1,492

Warranty reserve

866

597

Deferred revenue

532

466

Net operating loss ("NOL") carryforwards

211,724

215,545

Tax credit carryforwards

18,295

17,013

Depreciation, amortization and impairment loss

3,997

4,252

Other

5,498

5,434

Deferred tax assets

242,666

244,799

Valuation allowance for deferred tax assets

(232,555

)

(234,432

)

Deferred tax assets, net of valuation allowance

10,111

10,367

Deferred tax liabilities:

Federal benefit of state taxes

(10,111

)

(10,367

)

Net deferred tax assets

$



$



Because
of the uncertainty surrounding the timing of realizing the benefits of favorable tax attributes in future income tax returns, the Company has placed a valuation allowance against
its net deferred income tax assets. The change in valuation allowance for Fiscal 2013, 2012 and 2011 was $1.9 million, $3.4 million and $4.3 million, respectively.

The
Company's NOL and tax credit carryforwards for federal and state income tax purposes at March 31, 2013 were as follows (in thousands):

Amount

Expiration
Period

Federal NOL

$

592,005

2018 - 2033

State NOL

$

283,866

2013 - 2033

Federal tax credit carryforwards

$

9,577

2018 - 2033

State tax credit carryforwards

$

8,718

Indefinite

The
NOLs and federal and state tax credits can be carried forward to offset future taxable income, if any. Utilization of the NOLs and tax credits are subject to an annual limitation of
approximately $57.3 million due to the ownership change limitations provided by the Internal Revenue Code of 1986 and similar state provisions. The federal tax credit carryforward is a research
and development credit, which may be carried forward. The state tax credits consist of a research and development credit can be carried forward indefinitely.

Tax
benefits arising from the disposition of certain shares issued upon exercise of stock options within two years of the date of grant or within one year of the date of exercise by the
option holder ("Disqualifying Dispositions") provide the Company with a tax deduction equal to the difference between the exercise price and the fair market value of the stock on the date of exercise.
Approximately $27.7 million of the Company's federal and state NOL carryforwards as of March 31, 2013 were generated by Disqualifying Dispositions of stock options and exercises of
nonqualified stock options. In accordance with the reporting requirements under ASC 718, we did not include approximately $10.4 million of excess windfall tax benefits resulting from stock
option exercises as components of our gross deferred tax assets and corresponding valuation allowance disclosures, as tax attributes related to those windfall tax benefits should not be recognized
until they result in a reduction of taxes payable. The tax effected amount of gross unrealized net operating loss carry forwards excluded under ASC 718 was approximately $10.4 million at
March 31, 2013. When realized, those excess windfall tax benefits are credited to additional paid-in capital.

Accounting
Standards Codification ("ASC") 740, Income Taxes clarifies the accounting for income taxes by prescribing a minimum recognition threshold that a tax position is required to
meet before being recognized in the financial statements. ASC 740 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods,
disclosure and transition. Based on management's evaluation, the total amount of unrecognized tax benefits related to research and development credits as of March 31, 2013 and 2012 was
$2.4 million and $2.1 million, respectively. There were no interest or penalties related to unrecognized tax benefits as of March 31, 2013 or March 31, 2012. The amount of
unrecognized tax benefits that, if recognized, would affect the effective tax rate as of March 31, 2013 and March 31, 2012 was $2.4 million and $2.1 million, respectively.
However, this impact would be offset by an equal increase in the deferred tax valuation allowance as the Company has recorded a full valuation allowance against its deferred tax assets because of
uncertainty as to future realization. The fully reserved recognized federal and state deferred tax assets related to research and development credits balance as of March 31, 2013 and 2012 was
$9.6 million and $9.1 million, and $8.7 million and $7.9 million, respectively.

A
reconciliation of the beginning and ending amount of total gross unrecognized tax benefits is as follows (in thousands):

Balance at March 31, 2010

$

1,806

Gross increase related to prior year tax positions



Gross increase related to current year tax positions

167

Lapse of statute of limitations



Balance at March 31, 2011

$

1,973

Gross increase related to prior year tax positions



Gross increase related to current year tax positions

175

Lapse of statute of limitations



Balance at March 31, 2012

$

2,148

Gross decrease related to prior year tax positions

(100

)

Gross increase related to prior year tax positions

222

Gross increase related to current year tax positions

148

Lapse of statute of limitations



Balance at March 31, 2013

$

2,418

The
Company files income tax returns in the U.S. federal jurisdiction and various state, local and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S.
federal, state, local or non-U.S. income tax examinations by tax authorities for the years before 2008. However, net operating loss carryforwards remain subject to examination to the
extent they are carried forward and impact a year that is open to examination by tax authorities. The Company's evaluation was performed for the tax years which remain subject to examination by major
tax jurisdictions as of March 31, 2013. The Company settled its Internal Revenue Service examination of its U.S. federal tax return for the fiscal year ended March 31, 2010 during the
third quarter of the fiscal year ended March 31, 2012, with no findings that resulted in a change to the Company's financial statements. When applicable, the Company accounts for interest and
penalties generated by tax contingencies as interest and other expense, net in the statements of operations.

9. Stockholders' Equity

The following table summarizes, by statement of operations line item, stock-based compensation expense for the years ended March 31, 2013, 2012 and 2011 (in thousands):

In 1993, the Board of Directors adopted and the stockholders approved the 1993 Incentive Stock Plan ("1993 Plan"). A total of 7,800,000
shares of common stock were initially reserved for issuance under the 1993 Plan. In June 2000, the Company adopted the 2000 Equity Incentive Plan ("2000 Plan") as a successor plan to the 1993 Plan.
The 2000 Plan provides for awards of up to 11,180,000 shares of common stock, plus 7,800,000 shares previously authorized under the 1993 Plan; provided, however, that the maximum aggregate number of
shares which may be issued is 18,980,000 shares. The 2000 Plan is administered by the Compensation Committee designated by the Board of Directors. The Compensation Committee's authority includes
determining the number of incentive awards and vesting provisions. As of March 31, 2013, there were 7,059,019 shares available for future grant.

As
of March 31, 2013, the Company had outstanding 3,550,000 non-qualified common stock options issued outside of the 2000 Plan. The Company granted 250,000 of these
stock options during the second quarter of Fiscal 2013, 250,000 of these stock options during Fiscal 2012 and 3,050,000 of the options prior to Fiscal 2008 as inducement grants to new officers and
employees of the Company, with exercise prices equal to the fair market value of the Company's common stock on the grant date. Included in the 3,550,000 options were 2,000,000 options granted to the
Company's President and Chief Executive Officer, 850,000 options granted to the Company's Executive Vice President of Sales and Marketing, 250,000 options granted to the Company's Senior Vice
President of Program Management, 200,000 options granted to the Company's Senior Vice President of Human Resources and 250,000 options granted to the Company's Senior Vice President of Customer
Service. Additionally, as of March 31, 2013, the Company had outstanding 62,500 restricted stock units issued outside of the 2000 Plan. These restricted stock units were issued during the
second quarter of Fiscal 2013 as an inducement grant to the Company's Senior Vice President of Customer Service. Although the options and restricted stock units were not granted under the 2000 Plan,
they are governed by terms and conditions identical to those under the 2000 Plan. All options are subject to the following vesting provisions: one-fourth vest one year after the issuance
date and 1/48th vest on the first day of each full month thereafter, so that all options will be vested on the first day of the 48th month after the grant date. All outstanding options
have a contractual term of ten years. The restricted stock units vest in

equal
installments over a period of four years. Information relating to all outstanding stock options, except for rights associated with the Purchase Plan, is as follows:

Shares

Weighted-
Average
Exercise Price

Weighted-
Average
Remaining
Contractual
Term

Aggregate
Intrinsic
Value

(in years)

Options outstanding at March 31, 2012

10,039,651

$

1.41

Granted

1,958,330

$

1.01

Exercised





Forfeited, cancelled or expired

(206,216

)

$

2.16

Options outstanding at March 31, 2013

11,791,765

$

1.33

5.6

$

157,050

Options fully vested at March 31, 2013 and those expected to vest beyond March 31, 2013

11,560,603

$

1.34

5.5

$

157,048

Options exercisable at March 31, 2013

9,024,229

$

1.39

4.6

$

155,696

The
weighted average per share grant date fair value of options granted during the fiscal years ended March 31, 2013, 2012 and 2011 was $0.67, $1.19 and $1.02, respectively. There
were no options exercised during the fiscal year ended March 31, 2013. The weighted average per share grant date fair value of options exercised during the fiscal years ended March 31,
2012 and 2011 was $0.99 and $1.05, respectively. The Company recorded expense of approximately $0.9 million, $0.9 million and $1.5 million associated with its stock options for
the fiscal years ended March 31, 2013, 2012 and 2011, respectively. The total intrinsic value of option exercises during the fiscal years ended March 31, 2012 and 2011, was approximately
$0.6 million and $35,000, respectively. As of March 31, 2013, there was approximately $1.7 million of total compensation cost related to unvested stock option awards that is
expected to be recognized as expense over a weighted average period of 2.8 years.

The
Company calculated the estimated fair value of each stock option on the date of grant using the Black-Scholes valuation method and the following weighted-average assumptions:

Fiscal Year Ended
March 31,

2013

2012

2011

Risk-free interest rates

0.8

%

1.9

%

3.1

%

Expected lives (in years)

5.7

5.0

5.0

Dividend yield



%



%



%

Expected volatility

79.8

%

89.0

%

97.9

%

Weighted average grant date fair value of options granted during the period

$

0.67

$

1.19

$

1.02

The
Company's computation of expected volatility for the fiscal years ended March 31, 2013, 2012 and 2011 was based on historical volatility. The expected life, or term, of
options granted is derived from historical exercise behavior and represents the period of time that stock option awards are expected to be outstanding. Management has selected a risk-free
rate based on the implied yield available on U.S. Treasury Securities with a maturity equivalent to the options' expected term.

Stock-based
compensation expense is based on awards that are ultimately expected to vest and accordingly, stock-based compensation recognized in the fiscal years ended
March 31, 2013, 2012 and 2011 has been reduced by estimated forfeitures. Management's estimate of forfeitures is based on historical forfeitures. The following table outlines the restricted
stock unit activity:

Restricted Stock Units

Shares

Weighted
Average Grant
Date Fair
Value

Nonvested restricted stock units outstanding at March 31, 2012

1,143,262

$

1.20

Granted

919,414

$

1.00

Vested and issued

(469,911

)

$

1.15

Forfeited

(125,669

)

$

1.05

Nonvested restricted stock units outstanding at March 31, 2013

1,467,096

$

1.10

Restricted stock units expected to vest beyond March 31, 2013

1,358,386

$

1.10

The
restricted stock units were valued based on the closing price of the Company's common stock on the date of issuance, and compensation cost is recorded on a straight-line
basis over the vesting period. The related compensation expense recognized has been reduced by estimated forfeitures. The Company's estimate of forfeitures is based on historical forfeitures. The
restricted stock units vest in equal installments over a period of two or four years. For restricted stock units with two year vesting, one-half of such units vest one year after the
issuance date and the other half vest two years after the issuance date. For restricted stock units with four year vesting, one-fourth vest annually beginning one year after the issuance
date.

The
weighted average per share grant date fair value of restricted stock granted during the fiscal years ended March 31, 2013, 2012 and 2011 was $1.00, $1.47 and $1.04,
respectively. The total fair value of restricted stock units vested and issued by the Company during the years ended March 31, 2013, 2012 and 2011 was approximately $0.6 million,
$1.1 million and $0.8 million, respectively. The Company recorded expense of approximately $0.8 million, $0.7 million and $1.0 million associated with its restricted
stock awards and units for the fiscal years ended March 31, 2013, 2012 and 2011, respectively. As of March 31, 2013, there was approximately $1.0 million of total compensation
cost related to unvested restricted stock units that is expected to be recognized as expense over a weighted average period of 2.2 years.

During
the fiscal years ended March 31, 2013, 2012 and 2011 the Company issued a total of 103,574, 77,971 and 109,554 shares of stock, respectively, to non-employee
directors who elected to take payment of all or any part of the directors' fees in stock in lieu of cash. For each term of the Board of Directors (beginning on the date of an annual meeting of
stockholders and ending on the date immediately preceding the next annual meeting of stockholders), a non-employee director may elect to receive, in lieu of all or any portion of their
annual retainer or committee fee cash payment, a stock award. The shares of stock were valued based on the closing price of the Company's common stock on

the
date of grant, and the weighted average grant date fair value for these shares during each of the fiscal years ended March 31, 2013, 2012 and 2011 was $0.98, $1.20 and $0.91, respectively.

2000 Employee Stock Purchase Plan

In June 2000, the Company adopted the 2000 Employee Stock Purchase Plan (the "Purchase Plan"), which provides for the granting of
rights to purchase common stock to regular full and part-time employees or officers of the Company and its subsidiaries. Under the Purchase Plan, shares of common stock will be issued upon
exercise of the purchase rights. Under the Purchase Plan, an aggregate of 900,000 shares may be issued pursuant to the exercise of purchase rights. In August 2010, the Board of Directors adopted and
the stockholders approved an amendment and restatement of the Purchase Plan. The amendment and restatement includes an increase of 500,000 shares of common stock that will be available under the
Purchase Plan and extends the term of the Purchase Plan for a period of ten years. As amended, the Purchase Plan will continue by its terms through June 30, 2020, unless terminated sooner, and
will reserve for issuance a total of 1,400,000 shares of common stock. The maximum amount that an employee can contribute during a purchase right period is $25,000 or 15% of the employee's regular
compensation. Under the Purchase Plan, the exercise price of a purchase right is 95% of the fair market value of such shares on the last day of the purchase right period. The fair market value of the
stock is its closing price as reported on
the Nasdaq Global Market on the day in question. During the fiscal years ended March 31, 2013, 2012 and 2011, the Company issued a total of 22,478 shares, 21,338 shares and 25,133 shares of
stock, respectively, to regular full and part-time employees or officers of the Company who elected to participate in the Purchase Plan. As of March 31, 2013, there were 442,490
shares available for future grant under the Purchase Plan.

Stockholder Rights Plan

The Company has entered into a rights agreement, as amended, with Mellon Investor Services LLC, as rights agent. In connection
with the rights agreement, the Company's board of directors authorized and declared a dividend distribution of one preferred stock purchase right for each share of the Company's common stock
authorized and outstanding. Each right entitles the registered holder to purchase from the Company a unit consisting of one one-hundredth of a share of Series A Junior Participating
Preferred Stock, par value $0.001 per share, at a purchase price of $10.00 per unit, subject to adjustment. The description and terms of the rights are set forth in the rights agreement. Initially,
the rights are attached to all common stock certificates representing shares then outstanding, and no separate rights certificates are distributed. Subject to certain exceptions specified in the
rights agreement, the rights will separate from the common stock and will be exercisable upon the earlier of (i) 10 days following a public announcement that a person or group of
affiliated or associated persons has acquired, or obtained the right to acquire, beneficial ownership of 20% or more of the outstanding shares of common stock, other than as a result of repurchases of
stock by the Company or certain inadvertent actions by institutional or certain other stockholders, or (ii) 10 days (or such later date as the Company's Board of Directors shall
determine) following the commencement of a tender offer or exchange offer (other than certain permitted offers described in the rights agreement) that would result in a person or group beneficially
owning 20% or more of the outstanding shares of the Company's common stock. On June 9, 2011, the Company's Board of Directors unanimously approved a second amendment to the rights agreement,
which was approved by the stockholders in August 2011. The second amendment adds an additional "sunset provision," which provides that the rights agreement will

expire
on the 30th day after the 2014 annual meeting of stockholders unless continuation of the rights agreement is approved by the stockholders at that meeting. The second amendment also
provides for an update to the definition of "Beneficial Owner" to include derivative interests in the calculation of a stockholder's ownership. In addition, the second amendment clarifies the manner
in which the exchange provision of the rights agreement shall be effected. The rights are intended to protect the Company's stockholders in the event of an unfair or coercive offer to acquire the
Company. The rights, however, should not affect any prospective offeror willing to make an offer at a fair price and otherwise in the best interests of the Company and its stockholders, as determined
by the Board of Directors. The rights should also not interfere with any merger or other business combination approved by the Board of Directors.

Underwritten and Registered Direct Placement of Common Stock

Effective March 5, 2012, the Company completed a registered direct placement in which it sold 22.6 million shares of the
Company's common stock, par value $.001 per share, and warrants to purchase 22.6 million shares of common stock with an initial exercise price of $1.55 per share, at a price of $1.11 per unit
(the "2012 Warrants"). Each unit consisted of one share of common stock and a warrant to purchase one share of common stock. The 2012 Warrants expire on October 31, 2013. In addition, the
Company obtained the right to require investors in the offering to purchase up to an aggregate maximum of 19.0 million additional shares of common stock from the Company (the "Put Options")
during two option exercise periods, the first such option exercise period beginning September 10, 2012 and the second such option exercise period beginning March 4, 2013. Each Put Option
was subject to certain conditions which reduced the number of shares that could be sold or eliminate the Put Option. These conditions included a minimum volume-weighted average price (VWAP) and a
minimum average trading volume of the Company's common shares during the 30 trading days prior to the exercise of the Put Option. The March 2012 sale resulted in net proceeds of approximately
$23.1 million net of direct incremental costs of approximately $1.9 million.

On
September 18, 2012, the Company entered into an Investor Agreement with one of the investors in the 2012 registered direct offering pursuant to which the investor agreed to
(i) waive the condition precedent to the Company's exercise of the Put Option requiring the arithmetic average of the average daily trading volumes during the measurement period set forth in
the subscription agreement between the Company and the investor and on the exercise date be not less than 1.75 million shares and (ii) amend the subscription agreement to provide that
the purchase price of the additional shares during the first exercise period would be discounted pursuant to a formula that resulted in a purchase price for the first exercise period of $0.94 per
share. Additionally, pursuant to the Investor Agreement, the Company agreed to amend the exercise price of the 2012 Warrants originally issued to the Investor to $1.26. The exercise of the first Put
Option resulted in net proceeds of $4.2 million. The 2012 Warrants still outstanding as of March 31, 2013 provided for the purchase of 22.6 million shares at a weighted average
exercise price of $1.41 per share. On February 21, 2013, the Company entered into a letter agreement (each a "Letter Agreement" and, collectively, the "Letter Agreements") with each of the
investors in the March 5, 2012 registered direct offering. Pursuant to the Letter Agreements, the parties evidenced their mutual agreement that the Company would not exercise any portion of the
second Put Option. The Company chose not to exercise the second of the two Put Options because of its improved cash position and its desire to avoid stockholder dilution.

Effective
January 9, 2012, the Company entered into warrant exercise agreements with two holders of warrants issued by the Company on January 24, 2007 (the "2007 Warrants")
to purchase an aggregate of
1.6 million shares of the Company's common stock. Pursuant to the warrant exercise agreements, the holders agreed to exercise the 2007 Warrants at the existing exercise price of $1.17 in
exchange for fees in the aggregate amount of approximately $0.3 million. The net proceeds to the Company in connection with the exercise of these 2007 Warrants was approximately
$1.6 million.

Effective
November 21, 2011, the Company entered into warrant exercise agreements with (i) two holders of warrants issued by the Company on September 17, 2009 (the
"September 2009 Warrants") to purchase an aggregate of 5.8 million shares of the Company's common stock, (ii) four holders of warrants issued by the Company on September 17, 2008
(the "2008 Warrants") to purchase an aggregate of 2.4 million shares of the Company's common stock and (iii) six holders of 2007 Warrants to purchase an aggregate of 5.2 million
shares of the Company's common stock. Pursuant to the warrant exercise agreements, the September 2009 Warrant holders agreed to exercise the September 2009 Warrants described above at the existing
exercise price of $1.34 in exchange for a fee of an aggregate amount of approximately $5.4 million, the 2008 Warrant holders agreed to exercise the 2008 Warrants described above at the existing
exercise price of $1.60 in exchange for a fee of an aggregate amount of approximately $2.2 million and the 2007 Warrant holders agreed to exercise the 2007 Warrants described above at the
existing exercise price of $1.17 in exchange for a fee of an aggregate amount of approximately $1.8 million. The net proceeds to the Company, in connection with the exercise of the September
2009 Warrants, the 2008 Warrants and the 2007 Warrants, were approximately $8.4 million. The 2008 Warrants to purchase an additional 0.5 million shares were subsequently exercised on
November 22, 2011 at the existing exercise price of $1.60 in exchange for a fee of approximately $0.5 million, resulting in net proceeds of approximately $0.4 million.

Effective
March 9, 2011, the Company entered into warrant exercise agreements with (i) the only two holders of warrants issued by the Company on May 7, 2009 (the
"May 2009 Warrants") to purchase an aggregate of 3.6 million shares of the Company's common stock, (ii) one holder of 2008 Warrants to purchase 0.4 million shares of the Company's
common stock and (iii) four holders of 2007 Warrants to purchase an aggregate of 8.5 million shares of the Company's common stock. Pursuant to the warrant exercise agreements, the May
2009 Warrant holders agreed to exercise the May 2009 Warrants described above at the existing exercise price of $0.95 per share in exchange for a fee of an aggregate amount of approximately
$1.0 million, the 2008 Warrant holder agreed to exercise the 2008 Warrants described above at the existing exercise price of $1.60 per share in exchange for a fee of an aggregate amount of
approximately $0.2 million and the 2007 Warrant holders agreed to exercise the 2007 Warrants described above at the existing exercise price of $1.17 per share in exchange for a fee of an
aggregate amount of approximately $1.2 million. The net proceeds to the Company in connection with the exercise of the May 2009 Warrants, the 2008 Warrants and the 2007 Warrants, after
deducting expenses of approximately $0.4 million, was approximately $11.2 million. Immediately prior to the exercise of these warrants, the Company revalued the warrants and recorded a
charge of $6.9 million to operations during the three months ended March 31, 2011. The induced exercise of the warrants resulted in a reduction of the charge to operations by
$1.0 million during the three months ended March 31, 2011. The exercise of these warrants resulted in a reduction of the warrant liability of $9.7 million.

The FASB has established a framework for measuring fair value in generally accepted accounting principles. That framework provides a fair value hierarchy that prioritizes the inputs to
valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1
measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy are described as follows:

Level 1. Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets.

Level 2. Inputs to the valuation methodology include:



Quoted prices for similar assets or liabilities in active markets



Quoted prices for identical or similar assets or liabilities in inactive markets



Inputs other than quoted prices that are observable for the asset or liability



Inputs that are derived principally from or corroborated by observable market data by correlation or other means

If
the asset or liability has a specified (contractual) term, the level 2 input must be observable for substantially the full term of the asset or liability.

Level 3. Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The
asset or liability's fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.

The
table below presents our assets and liabilities that are measured at fair value on a recurring basis during Fiscal 2013 and are categorized using the fair value hierarchy (in
thousands):

Fair Value Measurements at March 31, 2013

Total

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

Significant Other
Observable
Inputs
(Level 2)

Significant
Unobservable
Inputs
(Level 3)

Cash equivalents

$

27,742

$

27,742

$



$



Warrant liability

$

(10

)

$



$



$

(10

)

Cash
equivalents includes cash held in money market and U.S. Treasury Funds at March 31, 2013.

The
table below presents our assets and liabilities that are measured at fair value on a recurring basis during Fiscal 2012 and are categorized using the fair value hierarchy (in
thousands):

Fair Value Measurements at March 31, 2012

Total

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

Quoted Prices in
Active Markets for
Identical Assets
(Level 2)

Significant
Unobservable
Inputs
(Level 3)

Cash equivalents

$

39,790

$

39,790

$



$



Warrant liability

$

(791

)

$



$



$

(791

)

Basis for Valuation

The carrying values reported in the consolidated balance sheets for cash and cash equivalents, restricted cash, accounts receivable and
accounts payable approximate fair values because of the immediate or short-term maturities of these financial instruments. As the Company's obligations under the Credit Facility are based
on adjustable market interest rates, the
Company has determined that the carrying value approximates the fair value. The carrying values and estimated fair values of these obligations are as follows (in thousands):

As of
March 31, 2013

As of
March 31, 2012

Carrying
Value

Estimated
Fair Value

Carrying
Value

Estimated
Fair Value

Obligations under the credit facility

$

13,476

$

13,476

$

10,431

$

10,431

The
Company adopted the amended provisions of ASC 815 on determining what types of instruments or embedded features in an instrument held by a reporting entity can be considered indexed
to its own stock for the purpose of evaluating the first criteria of the scope exception in ASC 815. Warrants issued by the Company in prior periods with certain antidilution provisions for the
holder are no longer considered indexed to the Company's own stock, and therefore no longer qualify for the scope exception and must be accounted for as derivatives. These warrants were reclassified
as liabilities under the caption "Warrant liability" and recorded at estimated fair value at each reporting date, computed using the Monte Carlo simulation valuation method. The Company will continue
to adjust the warrant liability for changes in fair value until the earlier of the exercise of the warrants, at which time the liability will be reclassified to stockholders' equity, or expiration of
the warrants.

Changes
in the liability from period to period are recorded in the Statements of Operations under the caption "Change in fair value of warrant liability."

The
fair value of the Company's warrant liability (see Note 9Stockholders' EquityUnderwritten and Registered Direct Placement of Common Stock) recorded
in the Company's financial statements is determined using the Monte Carlo simulation valuation method and the quoted price of the Company's common stock in an active market, volatility and expected
life, a Level 3 measurement. Volatility is based on the actual market activity of the Company's stock. The expected life is based on the remaining contractual term of the warrants and the risk
free interest rate is based on the implied yield available on U.S. Treasury Securities with a maturity equivalent to the warrants' expected life.

The
Company calculated the estimated fair value of warrants on the date of issuance and at each subsequent reporting date using the following assumptions:

Fiscal Year Ended
March 31, 2013

Fiscal Year Ended
March 31, 2012

Risk-free interest rates range

0.1% to 0.2%

0.0% to 1.5%

Contractual term (in years)

0.5 years to 1.2 years

0.1 years to 4.9 years

Expected volatility range

37.2% to 65.8%

60.5% to 84.9%

From
time to time, the Company sells common stock warrants that are derivative instruments. The Company does not enter into speculative derivative agreements and does not enter into
derivative agreements for the purpose of hedging risks.

As
discussed above, the Company adopted authoritative guidance issued by the FASB on contracts in an entity's own equity that requires the common stock warrants to be classified as
liabilities at their estimated fair value with changes in fair value at each reporting date recognized in the statement of operations. The table below provides a reconciliation of the beginning and
ending balances for the warrant liability which is measured at fair value using significant unobservable inputs (Level 3) (in thousands):